BUSI 489 Week 5 Targeted Financial Plan 5 Example

Targeted Financial Plan 5: Retirement Planning for the Whitaker Household

Goal and Assumptions

The Whitakers want Daniel to retire at 62, when Grace will be 60, on four-fifths of what they now bring home each year. All figures below are in today's dollars.

Capital Needed at 62

Between 62 and 67, before Social Security begins, the family must draw the full $87,744 a year from savings. The present value of five such years at 3 percent, with withdrawals at the start of each year, is about $413,900. From 67 to 95, Social Security covers $40,000 of the target, leaving $47,744 a year to draw. The present value of 28 years of those withdrawals, again taken at the start of each year and discounted back to age 62, is about $796,000. The total capital needed at 62 is therefore about $1,209,900.

Projected Savings and the Gap

Even with the increases already planned in the tax section, raising Daniel's deferral to 10 percent and adding Grace's $3,000 IRA contribution, annual saving reaches about $18,340, leaving a shortfall of about $9,800 a year.

This shortfall is real but not unusual. Scholz et al. (2006) compared households' actual wealth with optimal targets from a life-cycle model and found that most households near retirement had saved at least as much as the model called for, though a minority fell well short. Poterba et al. (2011) found that many households reach retirement with modest financial assets and rely heavily on Social Security and home equity, and that they draw their assets down slowly. The Whitakers' home equity and a long working runway put them in a stronger position than the gap alone suggests, but only if they act on it during the next ten years.

Where the Money Comes From

The adjustments below draw on cash flow the plan has already identified rather than on new sacrifices. The car loan ends in about three years; the credit cards end within the first year; and Daniel's salary is likely to grow faster than inflation over the next decade. Directing most of each raise to the 401(k), in the spirit of the automatic escalation discussed in the tax section, lets saving rise without the family feeling a cut in spending.

Risks to the Plan

Three risks could undo the projection. Returns may fall short of 4 percent after inflation for long stretches; a health problem or job loss could interrupt saving; and the Whitakers may live past 95. Conservative assumptions, regular reviews and the insurance recommended earlier address the first two in part, and delaying Social Security, which pays an inflation-adjusted income for life, addresses the third.

Closing the Gap

The first two adjustments alone add about $12,100 a year once in place, more than the remaining shortfall. Delaying Social Security beyond full retirement age increases the monthly benefit for each year of delay up to 70, which also strengthens Grace's survivor benefit, though it raises the bridge the family must fund from savings.

Recommendations

• Keep the staged 401(k) increases from the tax section and continue them to 15 percent of pay by Daniel's 47th birthday.
• When the car loan ends, redirect the full payment to Grace's IRA and, if she is eligible, to a Roth IRA, which adds tax diversification for retirement.
• Revisit the retirement projection every two years, and use 64 as the fallback retirement age if returns or saving fall short; two more working years both add savings and shorten the years to be funded.
• Consider a partial Roth conversion in low-income years early in retirement, before Social Security begins, to reduce required minimum distributions later.

Grable et al. (2012) and Lytton et al. (2012) emphasize that a retirement projection is a plan to be revisited, not a promise, and the schedule above reflects that.

A Christian Perspective

Proverbs 6:6-8 sends the sluggard to study the ant, an insect with no ruler over it that still lays up its harvest while the season allows (English Standard Version Bible, 2001/2016). Saving for retirement is that kind of quiet, steady preparation. The goal is not to hoard but to remain able to give, serve and avoid burdening others in later life.

References

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Grable, J. E., Klock, D. D., & Lytton, R. H. (2012). The case approach to financial planning: Bridging the gap between theory and practice (2nd ed.). The National Underwriter Company.

Lytton, R. H., Grable, J. E., & Klock, D. D. (2012). The process of financial planning: Developing a financial plan (2nd ed.). The National Underwriter Company.

Poterba, J., Venti, S., & Wise, D. (2011). The composition and drawdown of wealth in retirement. Journal of Economic Perspectives, 25(4), 95-118. https://doi.org/10.1257/jep.25.4.95

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