AuthorTopic: How to calculate of funding a retirement plan?
dede
@2015-03-01 08:12:59
Hi, my friend and i are studying level 1 and we decided to use the time value of money we have covered to calculate how much do we need to put aside to fund our retirement.

Currently we are both 28 this year. We want to retire at the age of 62 in 34 years time. Since our retirement plan in our country is using 4%, we decide to use 4% as the rate of return on our investments. We are calculating how much must we deposit at the end of each year for the next 34 years in order to be able to withdraw $42000 per year (which is $3500 per mth) at the begining of each year for the 24 years from age 62 to 82, assuming that our lifespan reaches 82.

In the end, each of us has a different calculation and after our debate, we still cannot find a conclusion. Therefore we agree to post our question here to get third part views on how do we calculate this problem.

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This is my method of calculating:

Since i need to withdraw $42000 at every beginning of the last 20 years, my calculation for PV in Beginning mode is:
N = 20, PMT = -42000, I/Y = 4%, CPT PV is $593625

Next the accumulation of the required amt over the next 34 years (before we retired) is (this time i using the end mode because i will contribute the amt at the end of the year, pls let me know if iím wrong at this part)
N= 34, I/Y=4%, FV = 593625, CPT PMT is $8497.6

My answers is $8497.6 every end of the year for the next 34 years until i retire at the age of 62.
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The calculation below is my friends calculation:

**************************************************He said that since $3500 per month is the amt required to draw out every mth after we retire, we need to factor in the inflation rate of 2%. Therefore his reason is we need to calculate what is the FV of the $3500 in 34 years time. (At this point of time, we agree on the inflation rate of 2% every year)

N=34, I/Y=2%, PV= $3500, FV = $6862.37
Therefore the future value of $3500 will be $6862.37 due to inflation. This is calculate in end mode.

Next he use this method to calculate what is the value using the 4% rate of return in Beginning mode

n=20, I/Y= 4%, PMT : (6862.37*12) = 82348, CPT PV is $1163902

Lastly he calculates the value of how much we need to contribute every year using the 6% rate. ( i think he is using 6% is because he is adding in the value of the rate of return which is 4% and the 2% inflation rate). He is using End mode in this calculation

N= 34, I/Y=6%, FV = 1163902, CPT PMT is $11172.
His ans is $11172 every end of the year for the next 34 years until we retire at the age of 62.
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Therefore which one is the correct way of calculating? Thanks for the advise :)
Wildcat
@2015-03-29 16:19:07
you answer ($8497) is correct if you only wish to receive a nominal payout of $42000 per year.

your friend wishes to calculate in real terms (by factoring inflation) which would make more sense if you wish to receive future payouts equivalent to the purchasing power of todays $3500. however your friend

CFA Discussion Topic: How to calculate of funding a retirement plan?

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