Your paper will be comprised of 3 sections: the retirement plan itself, a discussion section, and a question section. Please use headings to help organize your paper.
Section 1: Dr. Walden’s 8-Step Retirement Plan (1.5 pages)
- Base your analysis on Dr. Michael Walden’s 8-step plan detailed below. Personalize the steps to match your situation, but make sure you include every step (even if your answer for a particular step is 0). Explain the findings in your plan, and explain why you used the numbers and assumptions that you did. Talk me through the process you followed as you created your plan; e.g., I did this, and found out this, and this was exciting because ____, etc.
Section 2: Discussion (3.5 pages, reading files are attached)
- Discuss retirement issues that have been presented through class discussion or readings. A major portion of your paper should be spent discussing relevant issues, and how they will affect your retirement decisions. I am looking for original thought here, evidence that you have thought about these issues and how they will impact your life.
Section 3: Thought Questions (2 pages)
- Address the following questions (with headings) for the person on whom the project is completed. Use the question itself as the heading. Major thought should be put in to each question, and your answers for each question should be a minimum of one paragraph (2-3 sentences). If you are doing the project on yourself, answer the questions yourself; if you are doing the project on someone else, ask them and then answer the questions from their perspective.
- How will planning for retirement affect your future? (150 words)
- What impact will your personal retirement planning have on your immediate family? (150 words)
- What impact will your personal retirement planning have on society? (150 words)
- What impact would there be on the economy if every American had and implemented a retirement plan? (150 words)
Dr. Michael Walden’s Retirement Savings Procedure:
- Step 1: Pick a retirement age and the number of years planned for in retirement (e.g., the number of years you think you will be alive).
- Common retirement ages are 65, 67, or 70. You may pick one of these or choose your own.
- Twenty to thirty years are usually enough years to plan for being alive in retirement. Remember, it is always better to plan for too many years and have some money left over.
- It doesn’t really matter what age you pick, as long as you explain why you picked that age.
- Step 2: In current dollars, estimate the amount of money needed each year to live on in retirement, and then calculate the lump sum present value using a real interest rate.
- Use PVA for this calculation
- n = the amount of years you will be alive in retirement
- For your interest rate, use an r that you think you will be earning on your investments after inflation during the retirement years (e.g., a real interest rate)
- you can use whatever you think is best – just explain why you picked the r you did
- e.g. you can use 2% to be ultra-conservative (and place the burden of saving more capital on yourself), or 3% to match the inflation rate, or 7% because you want to invest in stocks, etc.
- Remember, you are estimating a real interest rate. If you pick 7% as your real r, then you will need to earn approximately 10-12% nominal r on your investments.
- Step 3: In current dollars, estimate the amount of Social Security payments received each year as retirement income. Calculate a lump sum present value of these SS payments using the real interest rate.
- Use PVA for this calculation
- The SS website reports monthly numbers – make sure you account for this in your calculations
- n = the amount of years you will be alive in retirement
- Use the same r you used in Step 2
- If you want to include Social Security, estimates can be found at http://www.ssa.gov/planners/calculators.htm (use Calculator 2: Online Calculator) or from your most recent earnings benefit statement sent to you from the SSA. If you use the calculator, when asked, pick that your estimated benefit will be reported in today’s dollars. If you are using SS, you must get a number from one of these places. You cannot use an example number reported in the class notes.
- If you do not want to include SS payments in your plan, put 0.
- Please note: Social Security is the name of a government program, so it is a proper noun and must be capitalized.
- Step 4: In current dollars, estimate the amount of other annual pension payments received from Defined Benefit pension plans as retirement income and calculate the lump sum present value.
- Use PVA for this calculation
- n = the amount of years you will be alive in retirement
- Use the same r you used in Step 2
- Only include numbers in this step if you currently work for a company that offers a DB pension, or if you plan on being a teacher, government worker, railroad worker, in the military, etc.
- Find out what the current formula for DBs are for the company you want to work for, and include that as your estimate. Otherwise, put 0 for this step.
- Step 5: Calculate the future value of assets which you own today that will be cashed in and added to the retirement nest egg at retirement.
- Include the current value of any assets, including Defined Contribution pension plans, here. Assets which you may want to include are your home, rental property, and/or stock portfolio. Calculate the future value using a calculated real interest rate.
- Use FV for this calculation
- You need a separate FV calculation for every asset you are planning to cash in at retirement. For example, if you have a 401(k) and a stock portfolio, you will need two FVs, one for the 401(k) and one for the portfolio.
- n = the number of years until you retire
- r should be a real interest rate based on the nominal interest rate you are currently earning on your investment. For example, if you have a 401(k) and it has been averaging a nominal return of 8% for the past 3 years, use the real interest rate formula to calculate the real rate of return to use in your FV for the 401(k).
- Do not tell me here that you will have a stock portfolio at retirement worth X amount if you do not already have a stock portfolio worth X amount. This step is only for assets that you currently have.
- Only include the value of your home in this step if you plan on selling your home at retirement and using the money to live on.
- Step 6: Calculate your financial retirement gap as Step 6 = Step 2 – Step 3 – Step 4 – Step 5.
- This step tells you if you need to save any more for retirement, or if you will generate enough income from SS, DBs, and the current value of your assets. If your answer for this step is 0 or <0, you can stop because you will have enough income; you will not need to complete the next two steps.
- To recap, Step 2 is the total amount of money you need invested the day you retire, and Step 3 is the income you will be receiving from SS, and Step 4 is the income you will be receiving from DBs, and Step 5 is the value of your assets.
- If you do not have enough income from SS or pensions or your assets to meet your retirement needs, you have a financial retirement gap and must invest more on your own.
- Step 7: Calculate the additional amount to save for retirement.
- Use FVA if you are currently contributing on a regular basis to a 401(k), Roth IRA, or stock portfolio.
- Use a real interest rate based on the nominal interest rate you are currently earning, and n = the number of years until you retire
- After your FVA calculation, subtract the answer from the answer to Step 6, and if you have a positive number, use PVP to determine the additional amount to invest
- If you are not currently investing for retirement, use PVP on the answer from Step 6.
- n = the number of working years until you retire
- r = the real interest rate you think you will earn on your investments from now until the day you retire
- Do not include any investments here with an FVA if you are not currently making any investments. However, you may discuss how your PVP answer is X, and you would like to invest that money in XYZ.
- Step 8: Calculate your retirement savings ratio. Add up the amount you are personally contributing to retirement on a regular basis (assets in Step 5 and the answer of Step 7), and divide that by your “current” income. Then, assuming your income rises with the average inflation rate, your retirement savings will also rise at the rate of inflation, maintaining the required standard of living.
- For “current income” you may use the income you estimate you will be making when you begin to invest for retirement. In fact, you probably want to use a post-graduation number here or else your plan may not be considered realistic for the purposes of this project.
- For example, if you calculate in Step 7 that you need to invest $7,000 a year for retirement, and you are currently making $10,000, do not use $10,000 in Step 8, because that is clearly not realistic. Instead, estimate your post-graduation income and use that number here.
- Some things to note:
- Make sure your plan has realistic assumptions and comes to realistic conclusions. If the first time you run the numbers you come up with something totally unrealistic, do it again with different numbers until your plan becomes reasonable. Make sure you tell me all of the interpolations and the steps that you used to come up with a realistic plan in your explanation. The whole point is to come up with a plan that is doable and workable and livable for your life; so if it is not all of those things, change your assumptions until you come up with a realistic plan.
- It is important to use the most accurate information possible; the more accurately you do this project, the more prepared you are for your future.
Example of the 8-step process:
Please note that I will use crazy numbers so that you will not be duplicating the example numbers. Also, I expect to see more explanation and/or discussion within each step than I am showing. Do not copy my example explanations word for word. That is plagiarism and you will be penalized.
- Step 1: I am 25 years old, and I plan on retiring at the age of 67. I will plan on being alive for 30 years in retirement.
- Step 2: I estimate that I will need $34,567 a year in retirement income. I will use a 3% real interest rate, because I am assuming that my post-retirement investments will grow at a rate of 3% more than inflation.
- Step3: I am not going to include Social Security in my analysis because ___________. Therefore, my answer for Step 3 is 0.
- Step 4: My profession is not likely to offer a DB pension; therefore, my answer for Step 4 is 0.
- Step 5: I have a 401(k) at my job that is currently worth $1,234. My 401(k) is invested in one mutual fund that is currently being traded for $45.67 a share. When I bought the mutual fund 3 years ago, the shares were trading for $34.56.
Using the Annualized Percentage Change formula, I see that I have averaged a 9.74% rate of return over the past 3 years.
Using the real interest rate formula and 3% inflation, my real interest rate is 6.54%.
The future value of this investment when I retire in 42 years is $17,654.
I also have a Roth IRA that is worth $567. According to my online statement, I see that I have averaged a 12.46% rate of return. Using the real interest rate formula, I know that the real interest rate is 9.18%.
The future value of this investment is $22,677.
(You may be able to find the average interest rate of your investment over the time period you have held it. If so, just use that rate and use the real interest rate formula; you will not need to do the Annualized Percentage Changes formula.)
- Step 6: = $677,528 – 0 – 0 – $17,654 – $22,677 = $637,197
- I need to save an additional amount for retirement; therefore, I need to complete steps 7 and 8.
- Step 7: I am currently investing $123 a month in my 401(k). Using the 6.54% real interest rate calculated above, and monthly compounding, the future value of my 401(k) in 42 years is
- I need to save, in addition to my 401(k), ($637,197 – $326,724) = $310, 473. I plan on investing directly in the stock market, so I will assume a 7% real interest rate, since that is what the stock market has returned on average over the last 100 years. Using the PVP formula and a 7% real interest rate, I know that I need to invest an additional $1,346 per year to have an adequate income in retirement.
- Step 8: My post-graduation income will be $34,567, so my retirement savings ratio is
- I will be investing $123 a month, which is $1,476 a year, and $1,346 a year, for a total of $2,822 per year.
- I need to save approximately 8% of my income for the rest of my life, so that my post-retirement standard of living will grow commensurate with my pre-retirement standard of living.
