tax planning recommendations Retirement Develop retirement planning strategies Create Planning Evaluate advantages and disadvantages of each retirement recommendations planning strategy Optimize strategies to make retirement planning recommendations Prioritize action steps to assist the client in implementing retirement planning recommendations Discuss with the client the impact of changes in assumptions on financial projections Estate Develop estate planning strategies, including living estate Create Planning planning recommendations Evaluate the advantages and disadvantages of each estate planning strategy Optimize strategies to make estate planning recommendations Prioritize action steps to assist the client in implementing estate planning recommendations Integrated Prioritize recommendations from the financial planning Create Financial areas to optimize the client’s situation recommendations Planning Consolidate the recommendations and action steps into a financial plan (written or iterative in an interactive format) Measure the progress toward achievement of the financial plan objectives Determine the appropriate process and cycle of review for the financial plan Accountant/Tax Adviser Lawyer Insurance Adviser Stockbroker/Securities dealer Mutual Fund Agent Real Estate Agent Trust Corporation CFP Final Level: Integrated Financial Planning Developing Effective Financial Plans: Module 3 Page 47
Retirement Capital-Needs Analysis A retirement capital-needs analysis determines the capital needed from all sources to support the estimated retirement income-funding goal, while allowing for the effects of inflation over the life expectancy of the client. Use this type of analysis to help pre-retirees understand how allocating assets and saving money can meet their retirement goals by ensuring sufficient income post-retirement. A common mistake is to assume that the income needed by the client after retirement can be based on a predetermined percentage. It is very easy to state that a client requires 70 to 80 percent or even 100 percent of income before retirement to be able to maintain their standard of living after retirement. (This percentage is referred to as the replacement ratio) However, such a percentage does not reflect the client’s true retirement needs and goals; it is only a guess. It is important to establish the retirement needs and goals of your clients more accurately, so you can more correctly calculate the retirement income need. A frequent assumption is that the amount of retirement income needed will be lower than during the pre-retirement period. This rule of thumb anticipates that obligations and expenses will be less or totally go away and that certain liabilities will be completely paid off before retirement. Assumptions also are made that retirees will scale down in their lifestyle (e.g., home and cars). Not only do retirees not always scale down their lifestyles, they often actually increase activities and related expenses. Retirement assumptions do not always take into account the fact that people live longer and will likely need more health care as they age. The cost of medical care can have a major impact on post- retirement income. TVM calculations enable you to calculate the future value of post-retirement income by using the value of money today and calculating a future value. With this future value, you know what amount of income the client will need in his or her first year following retirement. (This amount must be available each year during the post-retirement years.) The effect of inflation on the income required after retirement also must be kept in mind, which is why post-retirement income needs to grow at least with a rate equal to inflation. After establishing the income needed for the post-retirement years, calculate the amount (lump sum) at retirement to provide the client with the income required. The total must include any lump-sum amounts required to cover those debts and liabilities the client wishes to dispose of at retirement, or the cost for other expenditures, such as extended vacation travel. CFP Final Level: Integrated Financial Planning Developing Effective Financial Plans: Module 3 Page 48
Next, compare this lump sum (capital needed to provide the income) to the capital that will be available at the client’s retirement date. The difference between the two amounts indicates whether there will be a capital surplus or a shortfall. In summary, the following calculations are needed to determine whether the client has made sufficient provision for retirement: Establish (calculate) the retirement income required Calculate the amount of capital required at retirement to produce the retirement income needed Calculate the capitalized income available at retirement Calculate the shortfall Calculate the monthly or annual investment required, eliminating the shortfall if applicable The following information will enable you to do the required calculations. Present annual salary (income) Average percentage increase of salary (income) each year up to retirement Number of years to retirement and life expectancy (i.e., number of years in retirement) Percentage of the final salary (income) needed at retirement Percentage increase in income (retirement annuity) required after retirement Assumption on whether the retirement annuity will grow or remain fixed The client’s age at retirement Other capital available at retirement Example Sandra Smith is 50 years old and plans to retire in 15 years. Her annual salary is $100,000. She participates in a retirement fund at work, with a value of $850,000. She contributes 7.5 per cent, and her employer contributes 7.5 per cent of her salary to the fund each year. She also contributes $1,750 per year to a retirement annuity. The estimated fund value of the retirement annuity is $95,000. She intends to continue contributing to age 65. Sandra wants an after-tax retirement income of $80,000 per year in today’s (real) money terms through the age of 90. CFP Final Level: Integrated Financial Planning Developing Effective Financial Plans: Module 3 Page 49
Assumptions All instalments (including the income after retirement) are payable in advance. She expects her salary to grow at a rate of 5 per cent per year The net return on capital prior to retirement is 8 per cent per year The net return on capital after retirement is 7 per cent per year The income after retirement should increase at 5 per cent per year The inflation rate will be 5 per cent per year The expected effective tax rate applicable to her retirement income will be 20 per cent 95 per cent of the retirement annuity contribution is invested 1. Establish (calculate) the retirement income required As stated earlier, a rule of thumb can be used (i.e. x percentage of current income) or the income required for retirement can be more accurately established by looking at the client’s current cash flow. After reviewing the data (liabilities, debt, and living expenses) we have determined that the client will need after-tax income of $80,000 per year. 2. Calculate the amount of capital required at retirement to produce the retirement income needed CFP Final Level: Integrated Financial Planning Developing Effective Financial Plans: Module 3 Page 50
Calculate Income before Tax ($80,000 ÷ 0.8) (After tax) = $100 000 (before tax) Calculate (inflated value) Income per Year at Date of Retirement 100,000 PV 15 N 5 I/YR $207,893 Things to Remember First press Clear All Make sure the calculator is in Begin Mode CFP Final Level: Integrated Financial Planning Developing Effective Financial Plans: Module 3 Page 51
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