CHAPTER 16 Retirement Planning
Note that the ultimate question is shown by the formula on page 355:
Note also page 359 — average tax rates in retirement. In retirement planning
exercise, we suggest assuming a 20% AVERAGE tax rate. Many of your clients
might have lower average FEDERAL tax rates, but adding 3% to 5% for Ohio
income tax might bring the average tax rate up to 20% or so. However, a
moderate income client who will rely mostly on Social Security might have
a very low average tax rate, since in that situation, most of the income
will not be subject to federal income tax.
Note the top of page 361 — similar to our assumption in the Assignment
page 363: Life Expectancy at age 65: the life exp. is usually stated as
the average number of years a person is expected to live. Table 16.2 shows
that a 65 year old female has a 50% chance of living to 83, her life expectancy.
- For Assignment 8, please use the spreadsheet you can download from this web page:
Calculating life expectancy. It is the best method for couples. I will go over an example in lecture — for instance, if a husband is currently 33 and the wife is 30, and both will retire at 65, you would find their JOINT life expectancy in the year the wife will retire, so the husband will be 68 and the wife will be 65. The spreadsheet gives 21 as the joint remaining life expectancy. These numbers are for the average person at those ages today — it is likely that in 35 years, remaining life expectancies will be 5 years or more higher than the spreadsheet calculates.
Note discussion on pages 365-367. Please read this BEFORE asking your client
about desired spending in retirement.
Page 367-378 — be sure to read this discussion of different types of pensions
(DB versus DC, etc.) and retirement accounts.
Page 380: Social Security pensions — % of pension at “normal” retirement
age of 67 for those retiring after 2027
Is the wealth as of retirement enough to sustain spending (Consumption,
C) for however long the client might live?
aftertax income/(1-tax rate)
A 65 year old male today has 50% chance of living to 78, his life expectancy.
However, both have a 10% chance of living a lot longer, females to
101, males to 78.
For someone who is 30 now, does not smoke, and in reasonably good health,
if he or she lives to be 65, then at that point, life expectancy will probably
be a lot better than shown in this table — so, if you make it to 65, there
is an excellent chance you will live to be 100.
CHAPTER 17 Maturation of the Retirement Plan
SPECIAL RETIREMENT INSTRUMENTS
Annuities, p. 397
Reverse Mortgage, p. 399
SOURCES OF RETIREMENT INCOME, p. 401, etc.
- Example on pp. 405-406 is a little messed up, but does cover a common
choice facing couples at retirement
Corrected table, Ho. p. 405
If Wolfi lives
If Wolfi dies
Endowment Life Insurance
To make sure client do not outlive your money.
What are the advantages and disadvantages?
NOTE: if client will NOT annuitize financial assets at retirement,
tricky to plan on income at retirement — either have low real rate of
return on non-volatile investments (e.g., CDs) or volatile income stream
from stock portfolio.
Annual stock dividends might only amount to 1% of value of portfolio
If you have a large equity in your home, but need more income, don’t
want to move
It will be there, so you should assume so.
Do not assume your client’s pension is really a Defined
Benefit (DP) plan unless you get information on the formula for calculating the pension based on number of years worked, etc.
Sell home or get reverse annuity mortgage ?
Not a great investment…
Page 410 table
If you do not annuitize, 2 questions
1. What is your optimal portfolio allocation in retirement?
2. How much can you safely withdraw each year as a % of initial portfolio?
page 410, part of table
|W/C||65: M||65: F|
|10||100 (100% stocks)||100 (100% stocks)|
|.||.59 (59% chance of running out of money)||.72 (72% chance of running out of money)|
|28||40-60 (40% stocks, 60% bonds)||30-70 (30% stocks, 70% bonds)|
|.||.03 (3% chance of running out of money)||.05 (5% chance of running out of money)|
Note: W/C = 10 means that the first year of retirement, you take out C/W
= 0.10 or 10% of your portfolio, e.g., if your portfolio = $500,000, you
withdraw $50,000 each year in retirement. For a single male retiring at
65, the optimal portfolio for W/C = 10 is 100% stocks, but based on a projection
based on historical rates of returns, there is a 59% chance of running
out of money before he dies.
For a single female retiring at 65, the optimal portfolio for W/C =
10 is also 100% stocks, but based on a projection based on historical rates
of returns, there is a 72% chance of running out of money before she dies.
Note: W/C = 28 means that the first year of retirement, you take out
C/W = 1/28 = 0.0357 or 3.57% of your portfolio, e.g., if your portfolio
= $500,000, you withdraw $17,857 each year in retirement. For a single
male retiring at 65, the optimal portfolio for W/C = 28 is 40% stocks,
but based on a projection based on historical rates of returns, there is
a 3% chance of running out of money before he dies.
For a single female retiring at 65, the optimal portfolio for W/C =
28 is 30% stocks, but based on a projection based on historical rates of
returns, there is a 5% chance of running out of money before she dies.
I believe that you should evaluate the chance of running out of money
by considering your budget. Most retirees will have other sources of income.
For instance, I know a 78 year old woman whose spending is usually less
than her state pension. Her portfolio is 100% stocks, but all of her spending
from the portfolio income is for optional spending on her children and
grandchildren, so there is virtually no chance that she will run out of
On the other hand, if someone wants to spend $80,000 per year
in retirement, will retire at 65, and will have a $10,000 per year Social
Security pension, the table is very relevant — both in retirement, and
in planning for retirement. In this example, the projected annual gap is
$70,000 per year. What multiple should we use? The W/C levels in the table
on page 410 can give us guidance. Ignoring income taxes on retirement income,
a multiple of 10 would be very risky unless he could reduce spending in
years in which the market did poorly, and his portfolio SHOULD be 100%
stocks. (The analysis behind the table implies that for W/C = 10, he could
not do any better with other portfolio allocations.) To be confident that
he would not run out of money, he should plan on accumulating 28 times
the annual gap, or $1,960,000 (W/C=28.) Taking income taxes into account,
he would have to accumulate even more than that.
Our procedure for Assignment 8 assumes that your client will annuitize
all investment assets at retirement, and have a 3% real rate of return,
so the W/C ratio is effectively under 15 for a 20 year life expectancy. I
think this is a reasonable assumption in retirement planning before retirement,
but if your client would not annuitize, then having a multiple of 28 or
even 33 would be more prudent.