*Attach Excel Spreadsheets
This framework should be applied in recognition of the risk/return trade‐off and realistic associated financial assumptions. The goal of the project is to expose you to financial planning for retirement in a way that reinforces key financial management concepts and analytical tools developed in our course.
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 working 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, and3) 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.
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%.
Retirement Planning Questions
1. 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.
2. In conducting your analysis, upload a row in your spreadsheet model that tracks the amount in your retirement account balance. The account balance in each year should bring the prior year's balance forward one year at the assumed rate of return and then adjust for current year cash flows. In the excel spreadsheet make a line graph that portrays your account balance on the vertical axis and age on the horizontal axis. Looking at the graph, describe how the balance will change across time. Explain any kinks or changes in the slope of the line over your remaining life.
3. To assess progress over time toward achieving the described investment goal by age 67, indicate the needed assets‐to‐salary ratio at the ages of 40, 50, and 60.
4. What is the final balance in your retirement account? Explain why this is the case.
5. Explain how ignoring inflation would affect the financial outcomes.
6. Explain how taxes in general and the use of traditional tax‐sheltered investment accounts
(e.g., 401(k)) and Roth investment accounts (for general retirement investing apart from Roth
IRAs) would affect your financial outcomes. While you may feel free to quantify these effects, you are only required to explain the qualitative effects of them on your expected financial outcomes.
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