Chapter 16 - Mutual Funds, Insurance Companies, Investment Banks, and Other Financial Firms
If Mr. Smith is expected to need retirement income for 10 more years to age
75, he could ask to receive: Annual required income = $1 million /10 years = $100,000
However, this is risky because he may live beyond the age of 75.
If he drains
$100,000 per year automatically, the fund will be dangerously low in 10 years.
One important piece of information missing here is how much interest Mr.
Smith’s retirement fund will accumulate each year.
Even if he takes out $100,000 at the
opening of the first year of his retirement program, he will earn interest income on
$900,000 during the first year.
If the average return on those funds is 10 percent, he will
earn $90,000 in interest by the end of the first retirement year, giving him an account
balance of $990,000.
At the beginning of the second year he could draw out another
$100,000, leaving a balance of $890,000.
Clearly his accumulated wealth is falling, but
much more slowly than a straight-line approach would suggest because of the compound
There are at least three other factors that have not been considered in the
the expected rate of inflation over the retirement period;
b. Mr. Smith’s tax situation, especially his income tax bracket so we can
determine how much “take home” income he will receive; and
c. whether Mr. Smith has mandatory expenses (such as medical bills) which
must be paid each year, limiting his discretion over exactly how much income
he can draw out of the retirement fund each year.