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Chapter 11: Retirement issues.

what is it?

Most workers have a dream--and that dream often involves not working anymore. Of course, they realize that not working comes at a cost. That check that magically appears in their bank account or mailbox every so often will suddenly stop.

Retirement planning, therefore, is essentially the process of making sure there will be enough assets accumulated that workers can afford to stop working at a given age and still live their desired lifestyle for the rest of their lives. The process should begin long before the anticipated retirement. Hopefully, you will never have a client come in and say, "I am retiring on Friday and I want to make sure that I have enough saved..."

At its core, retirement planning is nothing more than cash flow planning. Cash flow planning is making sure the money will be there when it is needed. Before retirement, decisions are made to spend or to save. Every dollar spent reduces the amount that will be available for retirement. After retirement, every dollar that is spent reduces the amount of time the nest egg will last. Of course, the goal of planning is not to stash the funds away, never to see the light of day again. It involves an understanding, or even an education, that decisions made now can have a dramatic impact on resources later.

Typically, retirement planning should begin at least 15 to 20 years before retirement. This will normally place the clients solidly in their most valuable years with the maximum potential for savings. Starting earlier is difficult beyond encouraging the contributions into the company retirement plan since you are dealing with workers who are seeing money for the first time, developing their personal lifestyle, and starting families.

Of course, by starting so far in advance of retirement, assumptions are going to be necessary. Anything planned will need to be reviewed and updated. Inflation, expected investment returns, salary, bonuses, job changes, college costs, etc. may all change during the years before retirement. Some of the factors that should be considered when making these assumptions are explained below, under "Sensitivity of Assumptions."

For more information on retirement planning, please consult Chapter 29 of this book, and our sister publication, The Tools and Techniques of Employee Benefit and Retirement Planning.


1. Retirees are living longer than ever. The average retiree can expect to live 20 to 25 years after retirement.

2. Fewer businesses are offering company-funded pensions. Therefore, most of the funds needed for retirement will need to come from the worker. This is putting a heavier emphasis on savings in advance of retirement--and most workers do not start the savings process until they are in their late-30's.

3. Despite the fact that Social Security benefits do not begin until age 62, at the earliest, most workers will have retired before they reach that age. However, with the recent economic uncertainties and fall in the stock markets, many retirees have headed back to the workforce.

4. The average savings rate in the U.S. is under 3% of disposable personal income.


Step 1: Evaluate the current situation--The planner needs to obtain accurate information about the client's current assets and liabilities, cash flow needs, and major expenditures or inflows expected in the future.

Be sure to understand everything about the client's employment benefits. What retirement plans exist? Are they permitted to contribute the maximum allowed under the law? Does the company match any contributions? Are there any benefits available for retirees? See Chapter 29 regarding how to obtain this information with respect to employer-funded plans.

Step 2: Determine retirement needs--It is impossible to predict what a client's spending level is going to be at retirement. The best approach for planning purposes is to ask the client, if they were to retire now, would their spending go up, down or stay the same. From there, you can apply an appropriate estimate of inflation to arrive at the projected retirement lifestyle. Figure 11.1 (found at the end of this chapter) can be used to accumulate client information and estimate the retirement need.

Example: A client needs $60,000 annually (in current dollars) in order to retire. If the client is 10 years from retirement, that need will grow to $88,814 assuming a 4% inflation rate. If inflation continues at 4%, and the client is able to earn an investment return of 7% (after-tax), the client will need $1,374,059 at his retirement date.

If the client has absolutely nothing saved when you are brought into the picture, he would need to save nearly $7,900 per month assuming he can achieve that same 7% return. Hopefully, that situation will not come up too often!

Step 3: Getting to retirement--The capital requirements needed for retirement will often seem daunting, if not downright unattainable. This is where the planner's strategy is developed and implemented.

It is hoped that the client will have hired you well in advance of retirement. This will allow for the periodic review of goals, needs, and resources to determine if the plan is still on track. Keep in mind that the overall plan should be reviewed whenever there is a life-changing event or major change in the tax law.


As mentioned previously, financial planning is based in large part on assumptions that will be made about the future. Spending, inflation, and expected investment returns are only some of the factors that planners need to address when constructing a financial plan for a client.

How good are your assumptions? Time will tell, of course. Understanding how small changes in your assumptions affect long-range planning is an important aspect in explaining a plan to a client.

Let's consider inflation for a minute. A popular theme is that advances in technology are making things more affordable. But this isn't always the case. While it is true that a DVD player that was over $300 only a couple of years ago can be purchased for under $100 now, there is always a newer breed of technology that is commanding consumers' dollars. Look at the cost of televisions. You can spend as much or as little as you like. Technology has advanced to such a point that the older versions are being replaced by more expensive, powerful, and fancy models. Does that mean that your client needs to spend more? Not necessarily--but the lure of buying the bigger, better TV, for example is difficult to overcome. So, while advances in technology may bring down current prices of current models, those current models may become more difficult to find, own, and service as newer, more expensive models are continually being introduced to the public.

For retirees, inflation often doesn't have the same impact as it did when they were working. Most of their costs are more fixed, with the obvious exception of health insurance. The items that retirees tend to buy are not as impacted by inflation. Also, retirees tend to live further away from the big cities with the more inflated prices.

For example, Jack, a 65-year-old new retiree walks into your office with $2,000,000 of assets to support his retirement. He wants to know whether his assets will last for 20 years if he earns 6% after taxes. You look at him squarely in his eyes and say--"It depends..."

If you assume that inflation over the next 20 years will rise at 3% annually, Jack could spend $129,300 and have his money last. Jack breathes a sigh of relief and says--"That's good, I only spend $125,000 per year." However, if inflation rises to 5% per year, his annual lifestyle can be only $106,900 or else he will run out of money well in advance of his 20-year goal.

When dealing with expected returns on investments, most planners use a flat average annual rate of return. While this can work for simplicity's sake, do not overestimate this number--volatility, which is not considered in an assumed investment return, has a dramatic impact on the actual average rate of return.

Although the public has been educated by the media that volatility kills investment returns, it is rarely shown numerically. Consider the following. A planner uses a 10% average return in a client's financial plan. In five years, $100 grows to $161.05. Instead of assuming a flat 10% year-over-year return, what if the portfolio earned 20% in each of the first three years, then 5% in the fourth, but loses 15% in the fifth year. The "average" of those returns is still 10%, but the $100 only grows to $154.22. Figure 11.2 shows other 10% average returns and the impact on the portfolio after 5 years. Obviously, if you extend the time period further, the impact is that much more dramatic.

The sensitivity of assumptions is clearly something that should be discussed with clients in order to allow for as complete an understanding of their financial plan as possible. Be conservative with your assumptions--that way, if things turn out better, you have other opportunities to plan in the future with more resources at your client's disposal. If you are too aggressive, the client may end up without the resources he expected and you will be unlikely to get a second chance to plan for your client's future.


As retirement approaches, many clients will have a sense or know that they do not have the funds to achieve their goals. This is where the tough decisions often need to be recommended to the clients.

Housing--Should the client consider downsizing his or her home in order to lower housing costs (real estate taxes, mortgage, utilities, etc.)?

Health care--What provisions have been made or can be made for health care during retirement? Does the client understand exactly what and how much is not covered by Medicare? How much does supplemental health insurance (Medigap) coverage cost? Have the clients made provisions for long-term care?

Pensions and Social Security--What options are available for pension payouts? Should Social Security benefits be started before "normal" retirement age?

Many workers under age 40 are not even counting on Social Security existing in its current form when they become eligible to collect. For many, the benefits received do not even begin to put a dent in their overall retirement need. However, for too large a percentage of the population, Social Security is the only method of forced savings they have--and, ultimately count on that check arriving each and every month.

Keep in mind that the younger you are, the older you need to be to collect your full Social Security benefit. For those who were born after 1938, normal retirement age is greater than age 65. If you were born after 1959, normal retirement age is age 67 (see Chapter 29 for details).
Figure 11.1


Client's Name:______________________________

Address: ___________________________________

Telephone: (home)____________(office)_______

Business Address____________________________

Spouse's name:______________________________

Business Address:____________Telephone______


ASSETS Valuation as of date prepared unless otherwise indicated.

1. Cash and cash equivalents
                                               Current Return
                                 Value         (pretax)
  a. checking accounts           _____         _____
  b. savings accounts            _____         _____
  c. money market accounts       _____         _____
  d. life insurance cash

Total Cash/Cash Equivalents      _____         _____

2. Retirement Plans (Do not
include defined benefit plans)
                                 Current       Current
                                 Balance       Return

  a. IRA                         _____         _____
  b. Keogh                       _____         _____
  c. Section 401(k)              _____         _____
  d. Section 403(b)              _____         _____
  e. Other defined               _____         _____
  Total Retirement Plans         _____         _____

3. Investments
  (Do not include amounts
  included in 2 above)
                                 Market   Adjusted   Current Return
                                 Value    Basis      (pretax)

  a. Portfolio Investments
    (1) money market
    certificate of deposit       _____    _____      _____
    T bills                      _____    _____      _____
    commercial paper             _____    _____      _____

    (2) fixed-income
    U.S. government              _____    _____      _____
    U.S. agencies                _____    _____      _____
    municipal bonds              _____    _____      _____
    preferred stock              _____    _____      _____
    corporate                    _____    _____      _____
    notes receivable             _____    _____      _____
    (3) common stocks
    listed                       _____    _____      _____
    OTC                          _____    _____      _____
    restricted stock             _____    _____      _____
    (4) other portfolio
    options                      _____    _____      _____
    mutual funds                 _____    _____      _____
    physical assets              _____    _____      _____

  b. Passive Investments

    (1) direct participation     _____    _____      _____
    (2) real estate (passive)    _____    _____      _____

  c. Active Businesses

    (1) value of business        _____    _____      _____
    owned and operated
    (2) real estate              _____    _____      _____
    (active participation)

Total Investments

4. Personal Assets
                                 Fair          Adjusted
                                 Value         Basis

  a. primary residence           _____         _____
  b. other real estate           _____         _____
  c. household contents          _____         _____
  d. automobiles                 _____         _____
  e. other                       _____         _____

Total Personal Assets


1. Short-Term Liabilitie
(12 months or less)

                                 Balance   Interest   Monthly    Matu-
                                 Outs-     Rate       Payment    rity
                                 tanding                         Date

  Consumer credit (credit        _____     _____      _____      _____
  card & open charge accounts
  Personal notes payable         _____
  Loans from life insurance      _____     _____      _____      _____
  Notes guaranteed               _____     _____      _____      _____
  Other                          _____     _____      _____      _____
  Total                          _____     _____      _____      _____

2. Long-Term Liabilities

  Mortgages on personal          _____     _____      _____      _____
  Loans against investment       _____     _____      _____      _____
  Loans against personal         _____     _____      _____      _____
  Total                          _____     _____      _____      _____

3. Other
  Deferred taxes                 _____     _____      _____      _____
  Alimony, child support, etc.   _____     _____      _____      _____
  Judgements, etc.               _____     _____      _____      _____

Assets (fair market value)
  Total cash and cash            ___________
  Total retirement plans         ___________
  Total investments              ___________
  Total personal assets          ___________

  Total Assets                                        ___________

Assets (outstanding balances)

Total Liabilities


Estimated Retirement Living Expenses and Required Capital
(in current dollars)

                                 Per Month     Per Year
                                 x 12 =

1. Food                          _________     _________

2. Housing:
  a. Rent/mortgage payment       _________     _________
  b. Insurance                   _________     _________
  c. Property taxes              _________     _________
  (if not included in a.)
  d. Utilities                   _________     _________
  e. Maintenance (if you own)    _________     _________
  f. Management fee              _________     _________
  (if a condominium)

3. Clothing and Personal Care:
  a. Wife
  b. Husband
  c. Dependents

4. Medical Expenses:
  a. Doctor                      _________     _________
  b. Dentist                     _________     _________
  c. Medicines                   _________     _________
  d. Medical insurance to        _________     _________
  supplement Medicare

5. Transportation:
  a. Car payments                _________     _________
  b. Gas                         _________     _________
  c. Insurance                   _________     _________
  d. License                     _________     _________
  e. Car maintenance             _________     _________
  (tires and repairs)
  f.  Other transportation       _________     _________

6. Recurring Expenses:
  a. Entertainment               _________     _________
  b. Travel                      _________     _________
  c. Hobbies                     _________     _________
  d. Club fees and dues          _________     _________
  e. Other                       _________     _________

7. Insurance                     _________     _________

8. Gifts and Contributions       _________     _________

9. Income Taxes (if any)         _________     _________

10. Total Annual Expenses        _________     $________
  (current dollars)
  retirement needs worksheet

11. Inflation Rate until         _________
Retirement (I)

12. Total Years until            _________
Retirement (N)

13. Inflation Adjustment Factor                X________
[(1 + I).sup.N]

14. Total Annual Expenses                      =_________
(future dollars)

15. Inflation Rate               _________
Postretirement (i)

16. Aftertax Rate of Return      _________

17. Anticipated Duration of      _________
Retirement (n)

18. Inflation-Adjusted                         _________
Discount Factor
  A = 1+ i/1+ a

19. Capital Required at          _________
Retirement to
  Fund Retirement
  Living Expenses
  Amt line 14 x 1-
  [a.sup.n]/ 1+ a

20. One-Time Expenses                          +$_______

21. Total Capital Need
at Retirement                                  ________=$

Source: Robert J. Doyle, Jr., Retirement Planning Handbook, The
American College, Bryn Mawr, PA.

Figure 11.2

Rate  Index    Rate   Index    Rate   Index    Rate   Index

      100.00          100.00          100.00          100.00
10%   110.00    20%   120.00    20%   120.00   -30%    70.00
10%   121.00   -20%    96.00    20%   144.00   -30%    49.00
10%   133.10    10%   105.60    20%   172.80    50%    73.50
10%   146.41    -5%   100.32     5%   181.44    50%   110.25
10%   161.05    45%   145.46   -15%   154.22    10%   121.28
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Publication:Tools & Techniques of Financial Planning, 9th ed.
Date:Jan 1, 2009
Previous Article:Chapter 10: Education funding.
Next Article:Chapter 12: Special circumstances.

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