Mike Abbott, president of Retirement Planning, Inc., was delighted to receive a call from John Jordan John had been referred by Joe Jones, a local CPA. John was interested in planning for retirement. He had saved consistently over the years and participated in a company-sponsored retirement plan, John was not sure how comfortable he would be during his retirement years. Mike and John agreed to meet the following Monday to review John's finances. It was agreed that John's wife, Mary, would also attend the meeting. Mike's firm specializes in personal financial planning. The firm has developed a great deal of expertise in helping individuals develop comprebensive strategies for retirement. This area has proven to be very lucrative with the growing public awareness of the need to begin planning and saving for retirement as soon as possible. The objective of the initial client meeting was to obtain background information, explain the services offered by the firm, and discuss the fees for those services. During this meeting, Mike learned that John and Mary were both 62 years old. John is currently the vice president of marketing for EFC, Inc., a midsized manufacturing company. He has been with the company for 22 years. Mary is a homemaker. Mike asked John and Mary to describe their retirement objective. John said, "I'd like to retire in three years at age 65 and be comfortable. We want to be able to travel and spend time with our grandchildren. We also want to be able to spend a great deal of time on the golf course." It was obvious to Mike that John and Mary had not fully formulated their retirement goals. This was a common occurence; most clients Mike met with did not have a clear retirement objective established. To plan effectively for retirement, the following factors must be quantified: Target retirement age. Desired retirement income. Estimated life expectancy, Expected rate of inflation over the planning period. John and Mary had established their target retirement age but did not have a specific income. goal in mind. Moreover, they were unsure how to address this question. Mike suggested that they review their current spending patterns. By reviewing their checkbook register for the prior 12 months, John and Mary were able to document how much they spent for food, clothing, travel, entertainment, and other household expenses. They noted that they now spend $50,000 per year to maintain their present lifestyle. Some changes in spending would be expected at retirement. For example, job-related expenses (i.e., clothing, commuting, lunches, and payroll taxes) would decrease. However, travel and entertainment expenses would increase. It was decided that they would need $60,000 (pre-tax) per year in today's dollars at retirement. John's current income is $90,000 per year. Mike learned that both John and Mary are in good health. In fact, their family histories indicate that they could expect to live to age 85. The Jordans' assets are shown in Table 1. An investment account was established at ABC Securities 10 years ago. John and Mary relied heavily on the recommendations made by their broker, I. M. Slick. They believe their investments have performed adequately, but they don't really have a basis for comparison Previously, their investment experience had been limited to investing in certificates of deposit John also participates in the company's 401(k) plan. This deferred compensation plan allows John to contribute up to 15 percent of his salary before-tax. The company matches the first 3 percent John contributes. The annual addition to John's 401(k) account is expected to be $9,000, which will be invested in a diversified portfolio of mutual funds. The expected retum for this portfolio is 8 percent In addition, the Jordans each have an Individual Retirement Account at ABC Securities. The monies are invested in zero-coupon bonds which mature at John's retirement date. The bonds were priced to yield 8 percent annually. Mike was pleased to see that the Jordans have no debt other than the current balance on credit cards. Credit card debt is paid in full monthly so that finance charges are avoided. Finally, at age 65, John will begin receiving $22,000 per year in social security benefits. Mary will also qualify for social security based on John's earnings record. Her annual benefit will be $12,000. Now that Mike has gathered all the necessary information, his challenge is to determine if the Jordans can achieve their retirement income goal of $60,000 in today's dollars. Mike wanted to be sure that he presented a comprehensive assessment of the Jordans' situation. TABLE 1 John and Mary Jordan Investment Assets July 31, 1995 Account at ABC Securities $ 160,000 John's 401(k) 86,000 John's RA 22,300 Mary's IRA 11,000 Total Investment Assets $ 279,300. Questions in this assignment 1. How much in annual income will the Jordans require at retirement in three years when inflation averages 4 percent per year? Round off to the nearest $100 amount. (example: $15,687.38 = $15,700.00) 2. Assume that John will retire July 31, 1998. The Jordans will require the annual income computed in question 1 over their life expectancy. Assume the income stream will remain constant over years (i.e., there will be no inflation.) The payments will be received at the beginning of each year. How much capital would the Jordans require at Johns retirement to generate their desired income stream? Assume an 8 percent discount rate for the whole retirement period. 3. The Jordans are worried about the 8% rate of return on their investment(s) mya not be sustainable over a long period. They wish to be prepared. Assume 8% interest rate for the first 8 years of retirement and 5% of the remaining period. How much capital do the Jordans require? You will use this figure to ascertain whether the couple has saved enough in the following questions. 4. What will the value of the Jordans investment portfolio at ABC Securities grow to on July 31, 1998, if the expected rate of return is 8 percent? 5. What will be the value of the Individual Retirement Accounts on July 31, 1998, if they grow 8 percent annually 6. What will the 401(k) grow to on July 31, 1998, assuming an 8 percent annual return? Remember to take into account the annual additions made at the end of each year. 7. What is the lump-sum equivalent of the social security benefits the Jordans will receive? Ignore cost-of-living increases. Assume benefits will be paid annually; the first payment will occur on August 1, 1998. It is expected that 20 annual payments will be made. (Compute the present value using an 8 percent discount rate.) 8. Add your calculated values from questions 4 to 7. What is the total sum of the values of the couple's savings? 9. The Jordans broker, I.M. Slick, has recommended that they sell the zero-coupon bonds in their IRAs and invest the proceeds in a real estate limited partnership. This venture offers the opportunity for a 15 percent annual return. But, it also carries substantial risk. I.M. Slick will receive a commission of 8 percent of the monies invested in the partnership. Do you think this is an appropriate investment recommendation for Mr. Slick to make? Why or why not? Should the Jordans sell the bonds and invest in the partnership? Why or why not