Francis Navida Otero and Andrew Iamonaco have come to the office of Lopez Personal Planning to discuss their long-range retirement goals. They want to retire in 20 years. They have $10,000 in savings now and they are still paying off their mortgage. They also want to save money to help their son and daughter with post-secondary education. For the next five years while they finish paying off the mortgage, they can save $5,000 per year for daughter Alpha’s education. She will start post-secondary at the start of year eight. In years 6 – 20 they can save $20,000 per annum because the mortgage will be paid off. They will allocate $5,000 of it in years 6 – 10 inclusive to savings for son Beta’s post-secondary education. He is expected to start at the beginning of year 11. The rest of the savings go towards their retirement. They both will have good pensions, but they expect they will want to draw an additional $15,000 per year from savings for 30 years in retirement. They also want to take a world tour in their first year of retirement that will require an additional $100,000 on top of their pensions and the $15,000 annual draw from savings.
All the dollar figures are in today’s dollars. Planner Lopez notes that the current inflation rate is 1.3%, but to be cautious he assumes it will be 2% per annum in the future. They can invest their money at 8% nominal rate until retirement and then will be more conservative in their portfolio and earn 6% p.a. throughout retirement.
Their marginal tax rate is 42.7% now. It will drop to 31% when they retire
Question: Do they save enough with this plan to meet their retirement goal?
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As the fees for son and daughter's college education is not given, it is assumed that the savings and interest earned on the investment would be sufficient to cover the college fees.
Since the figures are in today's dollars, all the cash flows are in real terms and the interest rates have also been adjusted for inflation to reflect the real rates of return.
As savings are after tax, tax rate is not considered for calculations. It is assumed that the interest earned on investment would be offset by other strategies and the tax liability would be nil.
Real return before retirement 6.61% (It is assumed that inflation will be 2% after retirement)
Real return after retirement 3.92% ...
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