The primary analytical framework used to quantify the outcomes and enabling financial decisions is the time value of money. This framework should be applied in recognition of the risk/return trade-off and realistic associated financial assumptions.
Suppose you are 32 today, plan to retire at age 67, and expect to need retirement income starting at age 68 that has the same purchasing power as your final work
ing year's salary. All living expenses between now and retirement will be covered by your yearly salary. All living expenses after retirement will be covered by your yearly retirement income. Your retirement income will come from two sources: 1) withdrawals from your retirement account, and 2) Social Security benefits. Assume the first withdrawal from your retirement account for post‐retirement income occurs on your 68th birthday. Also assume you will start receiving Social Security benefits at age
68. If you were to begin receiving Social Security benefits today, you would receive $25,000. The amount you will receive in the future depends on inflation adjustments. Inflationary assumptions are described below.
You will provide for your retirement needs (above Social Security benefits) through three savings sources: 1) your own annual saving in the future; 2) your employer's annual contributions, and 3) your current accumulated savings to date. For simplicity, suppose you are paid on an annual basis and your salary next year will be $105,000 (to be paid on your 33rd birthday). Assume your next deposit and the employer contribution into your retirement account will occur one year from today (at age 33) and you will continue to deposit each year through age 67. In addition to your own saving, assume that your employer will also contribute an amount equal to 6.25% of your salary at each future payment time. Further, assume you have saved $79,000 to date. Fin 5654 Retirement Project Page 2 of 3 Finally, assume you wish to have $2 million at the end of your expected life (age 90) as a safety margin in case you live longer than expected. If you don't live long enough to use this safety sum, you will leave the remaining balance to your heirs at death.
You project that your salary will grow at a rate 1% higher than the long term average rate of inflation and that your retirement income needs will grow at the long-term inflation forecast. The higher growth rate in your salary reflects your expectation that you will receive raises and promotions on top of adjustments for inflation. The assumed investment rate for your working life is 5% above the long‐term inflation rate and declines to 3% above the inflation rate after you retire. Assume that the long‐term inflation forecast is 2.5% and that Social Security payments will be adjusted annually at the same rate of 2.5%.
QUESTION - NEED ATTACHED SPREADSHEET
- What percentage of your age 33 salary do you need to save to meet your expected needs?
Assume that you will save a constant percentage of your salary throughout your working life.
Find the solution to this problem by taking all cash flows to the present time, which is age 32.
Build a spreadsheet model to answer this question and solve for the needed amounts using
a time value of money model that includes the present or future values of the relevant
annuities or one‐time amounts. Solve first for a dollar amount of savings at age 33 and then
convert this into a percentage of your salary received at age 33. Note that you will be saving
the same percentage each year (ages 33 through 67 or for 35 years) and that your salary and
savings will grow at a constant rate.
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