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Wednesday, 8 August 2007

When Can You Retire: Case Study

In response to my recent post about the effects of savings rate and ROI on the age at which you can retire and reasonably expect your retirement savings to last until age 85, Fern wrote a comment requesting a review of her situation as an real world example. As I'm not a financial planner I can't give personal advice, so instead I'll just look at a hypothetical situation using Fern's figures as a starting point and adding in a few extra assumptions.
Model Parameters:
Person "X"
CUrrent Age: 48
Current Retirement Account Balance: $289,133
PV of Other investments to fund retirement: $142,158
Lifespan: 90
Target Retirement age: 60
Assumptions:
Salary Income: current=$59K
Salary Increase: real 1%pa until retirement age
Retirement accounts savings rate: 15%
Other investments savings rate: 0% (assume paying off mortgage from now til retirement)
Risk tolerance: moderate
ROI: retirement account: 4% real ROI (after tax and CPI deductions)
ROI: investment account: 3.5% real ROI (after tax and CPI deductions). Lower ROI than 401K due to higher tax impost.
5 year p/t work yielding $15K pa income during early retirement years (age 60 to 65).
Investment account is drawn-down first during retirement until exhausted, then retirement account
Same investment mix held during retirement years as while working.
Outcome of model:
Plugging those figures into a spreadsheet it appears that Person "X" can retire at 60 (still working part-time until 65) and the retirement and investment accounts balances should be able to fund an income of 70% pre-retirement salary until age 90 ($46K in today's $). Indeed, there may some surplus remaining in the account at age 90 ($497K) if the assumed ROI were attained. Over the entire investment period one would hope that the ROI's average out to close to the projected values, but there will obviously be some better and some worse years. A string of bad years early on in the piece can significantly reduce how long the retirement savings will last, even if later years are better and boost the overall average ROI. However, in this case person 'X' expects to being living in a home with no mortgage during retirement, so if funds run short in the later years (or if lifespan exceeds 90) borrowing against home equity (a "reverse mortgage") would be a possible solution, given that no residual estate is planned. Another "solution" would be to save extra to make up any performance shortfall in the accumulation stage, or attempt to live off smaller pension amounts during retirement if the funds were being exhausted too rapidly.
The projected real ROI of around 3.5% or 4.0% after tax seem reasonable from a historical return viewpoint for an investment mix of 80% in stocks (eg. 70% domestic index funds and 30% foreign stock index funds) and 30% in bond funds. However, even a small decrease in actual ROI can cut into this "surplus" significantly. For example if both retirement and investment accounts attained an ROI of 3.5% the final balance remaining at age 90 is only $207K.
If, during retirement, a run of good returns had boosted the remaining funds above what was required, the investment mix could be shifted to a lower-risk, lower return investment asset mix. Alternatively the "surplus" could be withdrawn and invested in a fixed-interest account for a rainy day while leaving the retirement and investment account asset allocations unchanged.
If one was fortunate enough to attain an real after-tax ROI of 4.5% on the retirement account and 4.0% on the investment account, retirement age could be brought forward to age 56 (assuming part-time work undertaken until age 65). But this would depend on the unlikely prospect that the same above-average returns could be maintained all the way through until age 90.
It may be possible to aim for such a retirement age, but you'd want to track your actual retirement and investment account balances (allowing for accrued tax liabilities and adjusting for actual inflation rates) over the next 10 years and be willing to postpone early retirement if returns were lower than expected. For example, the model projects the values (all expressed in today's $) listed below:

nb. "Pension" denotes withdrawals from investment and/or retirement account during retirement years.
Balances at end of Yr
Age Salary Savings Pension Retirement Investment
Account Account
48 $59,000 $8,850 - $309,584 $147,134
49 $59,590 $8,939 - $330,869 $152,283
50 $60,186 $9,028 - $353,131 $157,613
51 $60,788 $9,118 - $376,375 $163,130
52 $61,396 $9,209 - $400,639 $168,839
53 $62,010 $9,301 - $425,966 $174,748
54 $62,630 $9,394 - $452,399 $180,865
55 $63,256 $9,488 - $479,984 $187,195
56 $63,889 $9,583 - $508,766 $193,747
57 $64,527 $9,679 - $538,796 $200,528
58 $65,173 $9,776 - $570,124 $207,546
59 $65,824 $9,874 - $602,802 $214,810
60 $15,000 - $30,169 $626,914 $192,160
61 $15,000 - $30,169 $651,991 $168,176
62 $15,000 - $30,169 $678,071 $144,452
63 $15,000 - $30,169 $705,194 $119,339
64 $15,000 - $30,169 $733,401 $93,346
65 $15,000 - $30,169 $762,737 $66,444
66 - - $45,169 $793,247 $23,600
67 - - $45,169 $804,232 -
68 - - $45,169 $791,233 -
69 - - $45,169 $777,713 -
70 - - $45,169 $763,652 -
71 - - $45,169 $749,029 -
72 - - $45,169 $733,821 -
73 - - $45,169 $718,004 -
74 - - $45,169 $701,555 -
75 - - $45,169 $684,448 -
76 - - $45,169 $666,657 -
77 - - $45,169 $648,154 -
78 - - $45,169 $628,911 -
79 - - $45,169 $608,898 -
80 - - $45,169 $588,085 -
81 - - $45,169 $566,439 -
82 - - $45,169 $543,928 -
83 - - $45,169 $520,516 -
84 - - $45,169 $496,167 -
85 - - $45,169 $470,845 -
86 - - $45,169 $444,509 -
87 - - $45,169 $417,120 -
88 - - $45,169 $388,636 -
89 - - $45,169 $359,012 -
90 - - $45,169 $328,203 -

Bear in mind that this is only a simple model - tax effects have been eliminated by use of after-tax returns, and no allowance has been made for any social security, company pension or similar retirement income streams.

Copyright Enough Wealth 2007


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