FIN 350 Module 5 Milestone Two Example

Retirement Funding Analysis Using the Annuity Method

[Student Name]

Southern New Hampshire University

FIN 350: Advanced Personal Financial Planning

Milestone Two

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Retirement Funding Analysis Using the Annuity Method

Introduction

Milestone One found that Hannah and Dario Kessler, a composite Omaha couple aged 39 and 41, save about 10.5 percent of their income and have net worth well below what their income would suggest. Their retirement goal is to stop working when Dario is 65 and Hannah 63, in 24 years. This milestone calculates how much they will need at that date, how much their current savings will provide and how much they must save each year, using the annuity method.

Assumptions

Retirement planning assumptions

The $170,000 spending goal is about 65 percent of current gross income. That is reasonable because in retirement they will no longer pay payroll taxes, save for retirement or support children, but it assumes the mortgage is still being paid; a later scenario relaxes that.

Step 1: The Income Need in Future Dollars

Inflation of 3 percent a year for 24 years multiplies prices by 1.03 to the 24th power, or 2.033. The $108,000 the portfolio must supply, measured in current prices, becomes $108,000 x 2.033 = about $219,500 in the first year of retirement. Social Security is adjusted for inflation, so it is handled by subtracting it in today's dollars, as above.

Step 2: The Lump Sum at Retirement

The Kesslers will withdraw $219,500 at the start of the first retirement year and raise the withdrawal by 3 percent each year for 30 years, while the remaining balance earns 6 percent. That stream is a growing annuity due. Its value at retirement is:

PV = $219,542 x [1 minus (1.03 / 1.06) to the 30th power] / (0.06 minus 0.03) x 1.06.

The factor (1.03 / 1.06) to the 30th power is 0.4226, so the bracket equals 0.5774, divided by 0.03 gives 19.25, and multiplied by 1.06 for payments at the start of each year gives 20.40. The family therefore needs $219,542 x 20.40, about $4,478,900, on the day Dario turns 65.

Step 3: What Current Savings Will Provide

Their $262,000 of retirement and brokerage savings, growing at 6 percent for 24 years, becomes $262,000 x 1.06 to the 24th power = $262,000 x 4.049 = about $1,060,800.

Step 4: The Gap and the Annual Saving Needed

The gap is $4,478,900 minus $1,060,800, or about $3,418,100. The annual end-of-year saving that grows to that amount in 24 years at 6 percent is the gap multiplied by 0.06 and divided by (1.06 to the 24th power minus 1), or $3,418,100 x 0.06 / 3.049 = about $67,300 a year. The Kesslers currently save $24,560 a year toward retirement, so they would need to save about 2.7 times as much, an extra $42,700 a year.

Step 5: Scenarios That Close the Gap

A result this large calls for testing the assumptions that drive it rather than declaring the goal impossible.

Annual saving required under four scenarios

Lowering spending from savings to $90,000 is realistic if the mortgage, now on a 30-year schedule ending in 2053, is paid off before they retire; a few hundred dollars a month of extra principal, added once the card and truck loan are gone, would do it and remove about $22,500 a year of payments. Working two more years helps in three ways: savings grow longer, contributions continue and the retirement period is shorter, though this table conservatively keeps it at 30 years. A modestly higher return is possible if Hannah moves her stable value holding into a diversified fund, but it is the least reliable lever. The combined scenario reduces the required saving to about $46,800 a year, roughly $22,000 more than they save today.

Is the Target Realistic?

Saving $46,800 a year is about 18 percent of gross income. That is high but achievable: once the credit card and truck loan are paid off and Hannah's 401(k) contribution rises toward the 2025 limit of $23,500, the family can redirect about $1,800 a month to retirement saving. Research by Scholz et al. (2006) suggests that most American households save close to what a careful life-cycle plan would require, but the Kesslers' late start and large home purchase put them among those who must deliberately catch up. In the Save More Tomorrow program, workers who agreed ahead of time to send part of each future raise into their plan went from saving about 3.5 percent of pay to about 13.6 percent within roughly forty months (Thaler & Benartzi, 2004), a structure that suits this couple's anxiety about cutting spending now.

How the Plan Will Be Monitored

Because each input will change, the calculation should be rerun every year with actual balances, contributions and returns. If savings run ahead of the projection after a few strong years, the Kesslers can ease contributions or consider retiring earlier; if they fall behind, the levers above can be pulled again before the gap grows. A short annual review is far cheaper than a large correction in their late fifties.

Limitations

The calculation assumes steady returns, while real returns vary, and a poor decade at the start of retirement could require lower spending. It also omits the business: if Dario sells the company for even a modest price, the required saving falls. Social Security estimates may change. Lusardi and Mitchell (2014) note that few households run any calculation of this kind; doing so and updating it every year is more important than the precision of any single estimate.

Conclusion

To retire when Dario is 67 and Hannah 65 and spend $90,000 a year from savings in today's dollars, the Kesslers need to save about $46,800 a year, up from $24,560. The final plan will show how cash flow, debt repayment and account choices make that possible.

References

Lusardi, A., & Mitchell, O. S. (2014). The economic importance of financial literacy: Theory and evidence. Journal of Economic Literature, 52(1), 5-44. https://doi.org/10.1257/jel.52.1.5

Scholz, J. K., Seshadri, A., & Khitatrakun, S. (2006). Are Americans saving "optimally" for retirement? Journal of Political Economy, 114(4), 607-643. https://doi.org/10.1086/506335

Thaler, R. H., & Benartzi, S. (2004). Save more tomorrow: Using behavioral economics to increase employee saving. Journal of Political Economy, 112(S1), S164-S187. https://doi.org/10.1086/380085