egr 403 retirement planning - part ii 1 egr 403 introduction to retirement planning part i - basic...
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1EGR 403 Retirement Planning - Part II
EGR 403 Introduction to Retirement Planning
• Part I - Basic Approach
• Part II - Determine Capital to Invest• Part III - Saving Strategy
• Part IV - Investment StrategyClick here for streaming audio to accompany presentation
Dr. Phillip R. RosenkrantzIME Department, Cal Poly Pomona
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Part II - Determine Total Capital to Invest
• Estimate Living Expenses
• Determine rate of growth needed on your retirement capital to meet your goal
• Determine Capital needed to invest
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Determine Retirement Living Expenses
• Estimate living expenses
– Use current lifestyle and expenses
– Adjust for future plans and goals
– Include annual and semi-annual expenses
– Consider paying off your house
• Adjust for inflation by multiplying by (F/P, i%, n) where: – i = inflation rate and
– n = years to retirement
• Multiply by Tax Multiplier
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Tax Multiplier
• Non-tax income Living Expenses– $40,000 or less (1.10)– $60,000 or less (1.15)– $80,000 or less (1.20)– $100,000 or less (1.25)– Above $100,000 (1.30)– Add 0.05 if you have income from pension– Add 0.10 if you have part-time work income
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Personal Inflation
• Estimate inflation and increases/decreases in expenses over the course of retirement. – 3% - 3.5% is a reasonable historical average for
inflation. – Adjust up or down based on your increases,
decreases, or beliefs about inflation (e.g., in energy costs, food costs, etc.)
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Example
• You estimate you will need $100,000 (accounting for inflation) to live when you retire and you will not have a pension:– $100,000 x 1.25 = $125,000
• If part of the $100,000 will come from a pension, more will be taxable:– $100,000 x 1.30 = $130,000
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Why living off of investments results in lower tax liability
• Suppose you own ten investments worth $50,000 each for a total of $500,000
• They all go up 10% in value over the course of the year to a value of $55,000 each (total $550,000). You made $50,000!!
• You sell one of the investments to live on. Your taxable gain was only $55,000 - 50,000 = $5,000
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Determine Total Investment Return• Total Investment Return = Return on capital
invested + Inflation Adjustment. Therefore
Return on Capital Invested = Total Investment Return - Inflation
– Example 1: Suppose you expect 3% inflation and also expect to get 8% on your investment return. Then you would figure 5% return on your capital (assets) invested.
– Example 2: You expect 2% inflation and expect to get 11% on your investment return: Now you need to use 9% to determine your assets needed.
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Determine Total Investment Assets Needed
• Now divide your estimated living allowance by the return on capital invested to estimate Total Investment Assets (recall: P = A / i)– Example 1: $125,000 is your living allowance.
You figure 5% return on assets: $125,000 / (0.08 - 0.03) = $125,000 / 0.05 = $2,500,000
– Example 2: Same as above, but with 9% return: $125,000 / (0.11 - 0.02) = $125,000 / 0.09 = $1,388,889
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In other words...
• If you expect to get 8% return on your retirement investments and expect a 3% inflation rate, you need $2,500,000 in assets invested to maintain your lifestyle.
• If you expect to get 11% return and only expect 2% inflation, then you need much less: $1,388,889.