# Do the math: annual savings needed to reach nest egg goal.

Question: Tom is 50 and has $100,000 saved for retirement.
He'd like to retire at 60 and wants to have $1,500,000 in the bank
by then. Assuming his savings earns an average annual after-tax rate of
return of 7%, how much does Tom have to put away each year to have $1.5
million in 10 years?

Answer: The first question to answer is what the $100,000 already saved will be worth in 10 years. To determine this, we use the following equation:

[F.sub.10]=[F.sub.0] [(1+i).sup.10]

Where [F.sub.0] = $100,000 i = 7%

[F.sub.10] = Value of $100,000 in 10 years

So [F.sub.10] = [F.sub.0] [(1+i).sup.10] = $100,000 [(1.07).sup.10] = $100,000 x 1.967 = $196,700

Note: 1.967 can be obtained by doing the math, or by simply using a present-value table. See present-value factor table provided adjacent to this article. Locate the intersection of 10 years (periods) and 0.07 rate of interest, and you will find 1.967. Multiply this by [F.sub.0] and the result is $196,700.

So we can expect the currently saved $100,000 to be $196,700 when Tom reaches 60. His bogey is $1,500,000, so he needs to know how much money he has to stash away in each of the next 10 years to make up the $1,203,300 shortfall ($1,500,000 minus $196,700).

Let's label the $1,203,300 bogey R.

R = $1,203,300

Let's label the interest rate i.

i = 7%

Let's label the required annual contribution P.

P=?

The number of years available we'll label n.

n = 10

So here's the formula:

P=(R * i)/[[(1+i).sup.n] - 1]

Solving for P:

P = ($1,203,300 * .07) [(1 + .07).sup.10] - 1 = $84,231/([1.07.sup.10] - 1) = $84,231/(1.967 - 1) = $84,231/0.967 = $87,105

So for Tom to reach his goal of $1,500,000 in savings in 10 years, he has to invest $87,105 per year and earn an annual rate of return of at least 7%. The problem is that 7% after-tax rate of return is rarely achievable without taking a lot of risk--not recommended with retirement funds. But if the funds are in retirement accounts, then they are tax sheltered, and pretax return is the same as after-tax return. Pretax return of 7% is much more easily achieved. So he needs to get all this money into tax-sheltered retirement accounts. Assuming the $100,000 is already in such an account, all he has to do is place his annual savings into the same.

Is this possible? Take a look at the chart on page 13. Do you see the annual contribution limits for various retirement plan types? The only plan that will allow an annual contribution as high as $87,000 is the defined contribution plan. Talk to your financial advisor about putting one in place.

Answer: The first question to answer is what the $100,000 already saved will be worth in 10 years. To determine this, we use the following equation:

[F.sub.10]=[F.sub.0] [(1+i).sup.10]

Where [F.sub.0] = $100,000 i = 7%

[F.sub.10] = Value of $100,000 in 10 years

So [F.sub.10] = [F.sub.0] [(1+i).sup.10] = $100,000 [(1.07).sup.10] = $100,000 x 1.967 = $196,700

Note: 1.967 can be obtained by doing the math, or by simply using a present-value table. See present-value factor table provided adjacent to this article. Locate the intersection of 10 years (periods) and 0.07 rate of interest, and you will find 1.967. Multiply this by [F.sub.0] and the result is $196,700.

So we can expect the currently saved $100,000 to be $196,700 when Tom reaches 60. His bogey is $1,500,000, so he needs to know how much money he has to stash away in each of the next 10 years to make up the $1,203,300 shortfall ($1,500,000 minus $196,700).

Let's label the $1,203,300 bogey R.

R = $1,203,300

Let's label the interest rate i.

i = 7%

Let's label the required annual contribution P.

P=?

The number of years available we'll label n.

n = 10

So here's the formula:

P=(R * i)/[[(1+i).sup.n] - 1]

Solving for P:

P = ($1,203,300 * .07) [(1 + .07).sup.10] - 1 = $84,231/([1.07.sup.10] - 1) = $84,231/(1.967 - 1) = $84,231/0.967 = $87,105

So for Tom to reach his goal of $1,500,000 in savings in 10 years, he has to invest $87,105 per year and earn an annual rate of return of at least 7%. The problem is that 7% after-tax rate of return is rarely achievable without taking a lot of risk--not recommended with retirement funds. But if the funds are in retirement accounts, then they are tax sheltered, and pretax return is the same as after-tax return. Pretax return of 7% is much more easily achieved. So he needs to get all this money into tax-sheltered retirement accounts. Assuming the $100,000 is already in such an account, all he has to do is place his annual savings into the same.

Is this possible? Take a look at the chart on page 13. Do you see the annual contribution limits for various retirement plan types? The only plan that will allow an annual contribution as high as $87,000 is the defined contribution plan. Talk to your financial advisor about putting one in place.

Future value interest factor of $1 per period at i% for n periods, FVIF(i,n). Period 4% 5% 6% 7% 8% 9% 10% 1 1.040 1.050 1.060 1.070 1.080 1.090 1.100 2 1.082 1.103 1.124 1.145 1.166 1.188 1.210 3 1.125 1.158 1.191 1.225 1.260 1.295 1.331 4 1.170 1.216 1.262 1.311 1.360 1.412 1.464 5 1.217 1.276 1.338 1.403 1.469 1.539 1.611 6 1.265 1.340 1.419 1.501 1.587 1.677 1.772 7 1.316 1.407 1.504 1.606 1.714 1.828 1.949 8 1.369 1.477 1.594 1.718 1.851 1.993 2.144 9 1.423 1.551 1.689 1.838 1.999 2.172 2.358 10 1.480 1.629 1.791 1.967 2.159 2.367 2.594 11 1.539 1.710 1.898 2.105 2.332 2.580 2.853 12 1.601 1.796 2.012 2.252 2.518 2.813 3.138 13 1.665 1.886 2.133 2.410 2.720 3.066 3.452 14 1.732 1.980 2.261 2.579 2.937 3.342 3.798 15 1.801 2.079 2.397 2.759 3.172 3.642 4.177 16 1.873 2.183 2.540 2.952 3.426 3.970 4.595 17 1.948 2.292 2.693 3.159 3.700 4.328 5.054 18 2.026 2.407 2.854 3.380 3.996 4.717 5.560 19 2.107 2.527 3.026 3.617 4.316 5.142 6.116 20 2.191 2.653 3.207 3.870 4.661 5.604 6.728 25 2.666 3.386 4.292 5.427 6.848 8.623 10.835 30 3.243 4.322 5.744 7.612 10.063 13.268 17.449 35 3.946 5.516 7.686 10.677 14.785 20.414 28.102 40 4.801 7.040 10.286 14.974 21.725 31.409 45.259 50 7.107 11.467 18.420 29.457 46.902 74.358 117.391

Printer friendly Cite/link Email Feedback | |

Title Annotation: | RETIREMENT PLANNING |
---|---|

Publication: | The Business Owner |

Geographic Code: | 1USA |

Date: | Jan 1, 2007 |

Words: | 909 |

Previous Article: | Should Jimbo join the family business? |

Next Article: | Federal Reserve and Total U.S. Industrial Production. |

Topics: |