Case Study 2: Chads Retirement

Chad is a 49 year-old manager at an insurance company who earns $90,000 a year. He has a daughter about to graduate from college (Patti), and a 16-year old son who expects to get a juggling scholarship to attend Duke. Chad currently has $304,000 in his retirement account. He has earned an average return of 7.2% per year on his investments, and expects to continue doing so in the future until he retires 17 years from today. On the day Chad retires, he plans to shift his portfolio to more conservative investments from which he expects to earn 3.9% per year. In retirement, Chad wants to be able to withdraw $6,500 each month (starting one month from the day he retires). Hes obviously not sure how many years hes going to live after he retires, so he wants to evaluate three possible different retirement plans.

Retirement Plan 1: Receiving payments for 20 years after retiring and having nothing left in the retirement account

Retirement Plan 2: Receiving payments for 30 years after retiring and having $200,000 left in the retirement account

Retirement Plan 3: Setting up a trust that will pay $6,500 to himself (and ultimately his heirs) every month forever; the trust will have a 0.9% management fee, so the actual annual rate of return will only be 3.0%.

Part 1: Perform your analysis

For each of the retirement plans above, answer the questions below. Please include clear explanations of the calculations and inputs used in your work.

1. How much money will Chad need in his account on the day he retires?

2. Chad can start making monthly contributions to his retirement account one month from today. How much should he contribute each month?

3. Suppose Chad passes away 15 years into his retirement. How much money (or debt) would he have in his retirement account to leave to his heirs? How about 25 years into retirement? What about 35?

4. Suppose Chad can contribute $200 per month to his account from now until he retires. How much would his monthly withdrawals be if he follows the same timing & FV goal for each plan?

5. If Chad can only contribute $200 a month and is absolutely determined to follow each plan with withdrawals of $6500 a month, what rate of return would he need to earn before retirement to achieve this goal? Are there any drawbacks to seeking a return this high?

Part 2: Use the analysis to give advice

Based on your analysis above, write a short letter (1 to 2 pages) to Chad with your recommendations about his retirement planning.

Dont necessarily include every amount or calculation from above. Do explain which plan you think is best and why.

o Think about whats reasonable or possible given his income and family situation.

o Identify relevant trade-offs (What does trying to have more money in retirement mean for his current situation and life?)

o You can also write about what additional information or considerations might come into play; or you could even come up with your own set of recommended contributions/withdrawals.

Be sure to give a recommendation for what Chad should do if he was really going to be limited to $200 monthly contributions.

o When evaluating the plans, what are the trade-offs between Chads retirement income and what he leaves for his heirs?

o Which retirement plan would you recommend he pursue in this case, and why?