Jim and Anges Mitchem would like to retire in 30 years. They estimate that their
ID: 2796639 • Letter: J
Question
Jim and Anges Mitchem would like to retire in 30 years. They estimate that their retirement income needs will be 70% of the $64,000 current annual household expenditures. They expect to receive annual sodial security benefits $24,000 and annual employer pension funds $12,000 upon retirement. They are comfortable with getting an 8% annual return on their investment before retirement. They expect a 7% return on their assets after retirement and will stay retired for another 40 years. Assuming a 3% inflation rate, what would the annual savings needed to fund their retirement?Explanation / Answer
Solution:
Firstly, let us evaluate the couple's situation on retirement day:
Annual Expenses = 70% of $64,000 = $44,800
Annual Income on Retirement = $24,000 + $12,000 = $36,000
Shortfall in Income = $36,000 - $44,800 = ($8,800)
Therefore, $8,800 needs to met through regular return on their Savings as on the date of retirement.
Next, we need to determine the Investment amount as on the date of retirement which shall fund the couple's retirement by earning 7%.
From the above analysis, we can determine that 7% of the Total Investment Amount should amount to $8,800 to meet the couple's shortfall.
Therefore, Total Investment Required = 8,800/7% = $125,714.28
Now, the final step is to determine annual savings which, upon giving a return of 8% annually, shall accumulate to the required investment amount 30 years from now.
However, an inflation of 3% will actually result in net savings of 8-3 = 5% only.
Hence, 5% earnings on Annual Savings invested for 30 years should yield a cumulative sum of $125,714.28
Using a financial calculator or PMT function on excel, we can determine that the Annual Savings is approximately equal to $1892.2.
This amount needs to be invested for a period of 30 years at 5% so as to accumulate an amount of $125,715.28. The accumulated amount will then earn 7% to fund the annual shortfall of $8,800.
(Hope this is clear; please let me know in case you have any query on this)
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