Retirement Planning Retirement means different things to different people. For some, retirement means being sufficiently financially independent to travel and relax 24 hours a day. Others may view retirement as a "career change." However an individual views retirement will help determine how much he or she will need to retire. Will the lifestyle change dramatically in retirement, or will an individual continue doing the things you currently do, trading work for leisure and volunteering? Will they incur more expenses in retirement for leisure and travel, or will they prefer to spend more time with children, grandchildren and family?

To get better idea of what expenses will be when an individual is ready to retire, the expenses should be adjusted for inflation. Unfortunately, no one knows the future rate of inflation, so estimates must be made. The table below provides a multiplication factor for expenses for different rates of inflation. For example, if there are 10 years until retirement and one expects a 5% inflation rate, one should multiply the current expenses by the inflation table factor 1.63. A current need of $5,000 per year translates to a requirement of $8.150 per year, 10 years later - just to stay even (5,000 x 1.63).

Years To Retirement Current

Annual Rate of Inflation

3% - 4% - 5%

5 Years

1.16-1.22-1.28

10 Years

1.34-1.48-1.63

15 Years

1.56-1.80-2.08

20 Years

1.81-2.19-2.65

25 Years

2.09-2.67-3.39

30 Years

2.43-3.24-4.32

In determining the income that my parents will have at retirement, we need to add the various components. They will receive $30,000 per year from an annual pension from their employer. There is also Social Security. The amount of the Social Security monthly benefit to which the worker is entitled depends upon that earnings record and upon the age at which the retiree chooses to begin receiving benefits. Currently, the earliest age at which benefits are payable is 62. Should my parents choose to wait until age 66, ten years from now, to start receiving benefits, they will receive $1,150 per month, or $13,800 per year. This is a nice addition to other income, but hardly enough to live on by itself. Total defined benefit plans would be $43,800 per year.

Many experts claim that the average person needs 65% to 75% of their pre-retirement income. You can get a good idea of how much you need by examining your current lifestyle and adjusting it for your retirement vision. The best way to determine how much you will need in the future is to know what you need right now. Some people think they need their current income. That is not true. You need cash inflows to cover your current expenses, taxes, and savings for future needs. In retirement, you will need cash inflows to cover expenses and taxes only. You may wish to continue saving for your heirs, but that is not a need. Your expenses may change if you change your lifestyle, and your taxes will change depending whether your cash inflows are from income or a return of investment. In retirement, you will have the same expenses as you do today. Below is a list of expense items and the amount currently spent for them. The "Future Amount" column is the amount using the inflation table factor of 1.63, previously calculated.

Expenses

Current

Amount

Future

Amount

Housing: (rent, mortgage, taxes, utilities, repairs, insurance)

15,000

24,450

Groceries: (food, household supplies, dining out)

10,500

17,115

Personal: (clothing, dry cleaning, personal care)

3,500

Automobile: (payments, maintenance, gas, commuting, insurance)

7,000

11,410

Un-reimbursed medical expenses and medical insurance payments

3,500

5,705

Insurance: (life, disability, accident, and umbrella) not paid by employer

3,000

4,890

Recreation: (vacation, clubs, subscriptions, theatre, books, etc.)

4,500

7,335

Gifts to charity and others: (weddings, birthdays, holiday)

1,500

2,445

Interest on consumer loans and credit cards

3,000

4,890

Miscellaneous

6,000

9,780

Total

57,500

93,725

When we subtract my parents projected retirement expenses from their expected retirement income, we find we have a negative cash flow. This negative cash flow is our retirement cash flow deficit. Once we know what our retirement cash inflow deficit is, we can determine how much my parents need to save to make up the difference. Total expenses at the time of retirement would be $93,725. With only $43,800 in annual income, this leaves a shortfall of $49,925. One way to make up that shortfall would be to purchase an annuity using other assets. In our example, we added up retirement expenses, adjusted for inflation, and my parents anticipated Social Security and pension benefits, and we still need another $49,925 before taxes (retirement cash flow deficit). We estimate...

We expect my parents' investments to average 8% per year.
An annuity is a systematic withdrawal from an investment made periodically as a return of interest and principal. Under a single-pay annuity, an individual deposits a lump sum and withdraws the same amount each year until it is all paid back. This is an immediate annuity, which is an insurance policy that makes a series of either level or fluctuating payments, paid out over a fixed number of years or during the lifetime of one or two individuals, or in any combination of lifetime plus period certain guarantees. The overarching characteristic of the immediate annuity is that it is a vehicle for distributing savings. A common use for an immediate annuity might be to provide a pension income to a person who is about to retire. Below is part of an annuity factor table.

Years Of

Assumed Annual Percent Earnings Rate (per $1,000 savings)

Annuity

5

7

8

9

10

12

5

10

15

92

20

76

88

94

25

68

80

87

93

30

62

75

82

89

96

We can use this chart to help calculate how much we need to accumulate before retirement by dividing the annuity amount ($49,925) by the annuity table factor 108. Using the annuity table and formula, we can calculate the amount of savings needed using the formula, Savings = (Annuity Amount/Annuity factor) x 1,000. Substituting the Annuity Amount of $49,925, dividing by the annuity factor of 108 and multiplying the result by 1,000 gives us a required savings amount of $462,269. Since they currently have about $350,000 in liquid assets, and they are able to save $10,000 per year, they should have in excess of $460,000 in ten years, assuming their investments do not lose value. This will eliminate the need for my parents to have any employment after their retirement.

As part of their financial plan, I would urge my parents to purchase long-term care insurance. Statistically, most people will not become disabled, yet most Americans insist upon disability insurance. By contrast, almost everyone will need some type of long-term care, yet few consider insuring for that eventuality.

Long-term care insurance is an insurance product sold through a licensed insurance agent or an insurance broker that helps provide for the cost of long-term care beyond a pre-determined period. Individuals who require long-term care are generally not sick in the traditional sense, but instead, are old and frail and unable to perform some of the basic activities of daily living such as dressing, bathing, eating, toileting, getting in and out of a bed or chair, and walking. As an individual ages, there is an increased risk of needing long-term care. Medicare will not cover the expenses of long-term care, but Medicaid will for those who cannot afford to pay. Medicaid generally does not cover long-term care provided in a home setting, and in most cases, Medicaid does not pay for assisted living. However, Medicaid does provide services for people with low income or limited resources who "need nursing home care but can stay at home with special community care services."

People who need long-term care traditionally prefer care in the home or in a private room in an assisted living facility.

If home care coverage is purchased, long-term care insurance can pay for home care, often from the first day it is needed. It will pay for a live-in caregiver, companion, housekeeper, therapist or private-duty nurse up to 7 days a week, 24 hours a day. Assisted living is paid for by long-term care insurance as is adult day care, respite care, hospice care and more. Long-term care insurance can also help pay expenses for caring an individual who suffers from Alzheimer disease or other forms of dementia.

Many older individuals may feel uncomfortable relying on their children or family members for support, and find that long-term care insurance could help cover the expenses. Without long-term care insurance, the cost of providing these services may quickly deplete the savings of the individual and/or their family. Premiums paid on a long-term care insurance product may be eligible for an income tax deduction depending on the age of the covered person. Benefits paid from a long-term care contract are generally excluded from income.

At this point their parents should consider a diversified approach to investing. Risk in investing is made up of two types -- systematic and unsystematic. Unsystematic risk is that risk which is associated with individual companies. It can be reduced or even eliminated through diversification. Systematic risk is that which affects all companies at the same time, and it is usually considered that it cannot be reduced through diversification.

It is necessary to incorporate a disciplined, structured approach that takes into account their unique situation and needs, both today and in the future. It incorporates the following strategies: strategic asset allocation, long-term investing and professional management of assets.…