Retirement planning, Inc.

Mike abbott, president of Retirement planning, Inc., was delighted to receive a call from John Jordan 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 comprehensive 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 occurrence; 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. Morever, 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 Jordan's 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 dont really have a basis for comparison. Previously, their investment experience had been limited to investing in certificates of deposit. John also participants in the companys 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 Johns 401(k) account is expected to be $9,000 which will be invested in a diversified portfolio of mutual funds. The expected return for this portfolio is 8 percent. In addition, the Jordan's each have an individual retirement account at ABC securities. This monies are invested in zero-coupon bonds which mature at Johns retirement date. The bonds were priced to yield 8 percent annually. Mike was pleased to see that the Jordan's have no debt other than the current balance on credit cards. Credit cards is paid in full monthly so that finance chargers 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 Johns earnings record. Her annual benefits will be $12,000. Now that mike has gathered all the necessary information, his challenges is to determine if the Jordan's can achieve their retirement income goal of $60,000 in todays dollars. Mike wanted to be sure that he presented a comprehensive assessment of the Jordan's situation.

TABLE I

JOHN AND MARY JORDAN INVESTMENT ASSESTS

JULY 31, 1995

Account of ABC securities $160,000

Johns 401 (k) $86,000

Johns IRA $22,300

Marys IRA $11,000

TOTAL INVESTMENT $279,300

1. The Jordan's are worried about the 8 percent rate of return on their investment $65,000.000 my not be sustainable over a long period. They wish to be prepared. Assume 8% interest rate for the first 8 years of retirement and 6% of the remaining period. How much capital do the Jordan's require?
2. What is the lump-sum equivalent of the social security benefits the Jordan's will receive? Ignore cost-living increases. Assume benefits will be paid annually; the first payment will occur on august1, 1998. It is expected that 20 annual payments will be made. Compute the present value using 8 percent discount rate?
3. According to your calculations for questions 1 and 2, will the Jordan's be able to achieve their retirement income objective?