Case 2

Victor and Maria's Retirement Plans

Victor, now age 61, and Maria, age 59, plan to retire at the end of the year. Since his employer changed from a defined-benefit retirement plan to a defined-contribution plan ten years ago, Victor has been contributing the maxi- mum amount of his salary to several different mutual funds offered through the plan, although his employer never matched any of his contributions. Victors tax-sheltered account, which now has a balance of $300,000, has been growing at a rate of 7 percent through the years. Under the previous defined-benefit plan, today Victor is entitled to a single-life pension of $360 per month ($4,320 annually) or a joint and survivor option paying $240 per month ($2,880 annually). The value of Victors investment of $20,000 in Pharmacia stock some years ago has now grown to $56,000. Marias earlier career as a medical records assistant provided no retirement program, although she did save $10,000 through her credit union, which was later used to purchase zero-coupon bonds now worth $28,000. Marias second career as a pharmaceutical representative for Pharmacia allowed her to contribute to her retirement account over the past nine years, which is now worth $98,000. Pharmacia matched a portion of her contributions, and that match is now worth $70,000; its growth rate has ranged from 6 to 10 percent each year. When Marias mother died last year, Maria inherited her home, which is rented for $1,800 per month; the house has a market value of $300,000. The Hernandezes personal residence is worth $260,000. They pay combined federal and state income taxes at a 30 percent rate.

(a) Sum up the present values of the Hernandezes assets, excluding their personal residence, and identify which assets derive from tax-sheltered accounts.

(b) Assume that the Hernandezes sold their stocks, bonds, and rental property, realizing a gain of $34,000 after income taxes and commissions. If that sum plus their tax-sheltered accounts earned a 7 percent rate of return over the Hernandezes anticipated 20 years of retirement, how large an amount could be withdrawn each month? How large an amount could be withdrawn each month if they needed the money over 30 years? How large an amount could be withdrawn each month if the proceeds earned 6 percent for 20 years? For 30 years? Hint: Use Appendix A4.