Overall Retirement Plan + Children Education Plan - Two Kids Plan

Mr. E aged 35 years old, plans to marry now and hopes to have two kids - 1st kid right after marry and 2nd kid one year after marry. What is the retirement fund and children education fund for the overall family plan?

Assumption:
1) His wife and Mr. E are same age
2) His wife and Mr. E plans to work till 60 years old
3) His hife has monthly RM500 EPF contribution with the beginning saving of RM40,000 at the Account I and Account II. EPF annual dividend is 6.0% p.a.
4) Mr. E's asset appreciation at  pre-retirement rate of 10% p.a. while post-retirement rate of 8% p.a., salary increment at 5% p.a., cost of living inflation at 3.2% p.a.,
5) Children Education fees (school fees and living cost) RM25,000 p.a., inflation at 6% p.a., education fund performance at 8%. p.a.
6) Miscellaneous expenses: RM1,500 monthly for contingency reserve 

Financial Planning approaches:
1) Target Replacement Ratio: 80%
2) Retirement fund calculation - principal liquidation

 V@35 denotes Mr. E's value at current age while V@60 denotes Mr.E's value at retirement age. It has a negative net worth after the consideration of offsetting liabilities with the asset. Thus,
Mr. E has to plan some action for his retirement fund and children education fund preparation.

You can replace the Mr. E figures by yours. Check and see the result.


The previous result is based on the assumption 4, 10% p.a. for the net worth appreciation CAGR. What is the desired return that Mr. E required in order to have the net worth at RM 0?
By using solver, 11% p.a. CAGR is calculated. Thus, he needs to ensure that his asset appreciation must be over 11% p.a.

However, Mr.E required a house and a car ++ till 85 years old. So, the solver is re-simulated by reserving 395k@60 years old. Thus, he needs to ensure that his asset appreciation must be over 11.28% p.a.

After the study of his portfolio CAGR return, which is 13.2% p.a. When will be his financial freedom age?

From solver, his financial freedom age is 40 years old. Thus, he has to ensure his portfolio return can generate 13.2% p.a. CAGR every year till 85 years old.

Retirement Plan Construction

3 Steps to construct retirement plan: Retirement income need, retirement fund required and funding/accumulation.

Step 1: Retirement income needed
Retirement income approaches: (A) Target replacement ratio (TRR) and (B) Expense Method
For TRR, 50%-70% of expected last drawn salary is calculated in order to replace the expenses. It is assumed that less commitment approaches retirement age. Once retired, you no need to pay tax, EPF, loan (depends on housing and car loan are cleared) and Educational fund (depends on your funded resource). Different person has different ratio. Thus, it is proposed based on the personal objective, net worth and cash flow.

Step 1(A): Retirement income needed – Target replacement ratio (TRR)
Cat, 32 years old, she earns 10,000 monthly. Her yearly increment is 5%. She plans to retire around 65 year old.
Her last drawn salary, FV(5%, 65-32-1,0,-120000,0) = $571,792.98
Assumption:
TRR(50%, e.g. less commitment) = $285,896.49
TRR(60%, e.g. child educational funded by own, bad health family members etc) = $343,075.79
TRR(70%, e.g. loan not clear yet, child educational funded by own, bad health family members etc) = $400,255.08
Higher TRR produces higher security but high cost too. Thus, another method is studies.
Step 1(B): Retirement income needed – Expenses method
Cat’s outflow is 45,000. Let’s add 10% buffer. Thus, it is assumed as 50,000. Inflation is 5%.
Future annual expenses at age 65 year old is FV(5%, 65-32,0,-50000,1) = $250,159.43

Step 2: Retirement Fund calculation
Let’s take future annual expenses at age 65 year old is $250,159.43.
Life expectancy (Malaysian: 75 years old, Singaporean: 85 years old). Medical development human life is getting more advances. Thus, it will be reviewed time from time.
Two approaches for the retirement fund calculation: (A) principal liquidation and (B) Principal intact.

Step 2 (A): Retirement Fund calculation – principal liquidation
Cat is a Singaporean PR. She plans to stay and work at Singapore for the rest of her life.

Figure 1: Malaysian 30-years historical fixed deposit rate and consumer price index

With ROI 8% p.a, Inflation = 0%. Retirement fund, 2Ai, = PV(0.08,85-65,-250159.43,0

,1) = $2,652,590.33
With ROI 8% p.a, Inflation = 5%. Retirement fund, 2Aii, = PV((0.08-0.05)/(1+0.05),85-65,-250159.43,0,1) = $3,879,129.82

Step 2 (B): Retirement Fund calculation – Principal intact.
With ROI 8% p.a, Inflation = 0%. Retirement fund, 2Aiii, = PV(0.08,999,-250159.43,0,1) = $3,377,152.31 or (250159.43/0.08)+250159.43 = $3,377,152.31
With ROI 8% p.a, Inflation = 5%. Retirement fund, 2Aiv, = PV((0.08-0.05)/(1+0.05),999,-250159.43,0,1) = $9,005,739.48 or (250159.43*(1+0.05)/(0.08-0.05))+250159.43 = $9,005,739.48

From 2Ai, 2Aii, 2Aiii and 2Aiv, it is recommended 2Aii, $3,879,129.82 realistically.

Scared?

Step 3: Retirement Funding Calculation
Insurance/UT agent will based on the $3,879,129.82 to work out the annual payment, PMT(0.1,65-32,0, 3879129.82,0) = ($17,453.78) annually in order to close the deal fast.

Professionally, net worth that we had discussed earlier will be use to off the retirement fund funding.
Item in the present value of Net Worth will be projected at year 65 years old to offset the retirement fund because financial plan implement. It might be the additional add-on to net worth e.g inherit of parent assets. Thus, it is advised to have a review if net worth has changed.
Cat has share/unit trust – 200,000, own-occupied house – 130,000, car – 35,000, CPF – 150,000. Her insurance has no cash value because she bought term insurance. She doesn’t invest in any houses. She has no car loan but house loan – (76,000).

Current asset that we discuss over her is net investment asset, NIA.
NIA is the total sum of asset that exclude of house and car. Thus, NIA is 200k+150k =350k@32 years old.

Share/UT’s ROI is 10% p.a while CPF is 2% p.a. Increment 5.5%p.a
FV@65, Share/UT = FV(0.1,65-32,0,-200000,1) = $4,645,030.88
FV@65, CPF = FV(0.02,65-32,0,PV((0.02-0.055)/(1+0.055),65-32,120000*(0.2+0.15),0,0)/(1+0.055),0) = $4,716,156.49 with no withdrawing.
Total NIA@65 = $9,361,187.38, Requirement retirement fund@65 = $3,879,129.82
Thus, NIA>required fund, she doesn’t need to have a retirement fund. She must be very careful in taking care of her investment.

Let us upgrade the scenario, may she stop her employment? Another words, can she retire now by taking dividend to support 50k living?
FV@65, Share/UT = FV(0.1,65-32,0,-200000,1) = $4,645,030.88
FV@65, CPF = FV(0.02, 65-32,0,-150000,0)= $288,334.71
NIA@65 = $4,933,365.59, Requirement retirement fund@65 = $3,879,129.82
Thus, NIA>required fund, she doesn’t need to worry about her retirement plan. She must be very careful in taking care of her investment. But, she need to source for another income to support her 50k p.a living.

Said, dividend yield is 6%p.a. share/UT = 200k. Thus, dividend paid = 12k p.a
PV, begin = (50000/0.06)+50000 = $883,333.33. She needs to accumulate current value of $683,333.33.

Conclusion: Cat has no worry in retirement. She doesn’t even require a retirement plan. If she wants to immediately quit the current job and taking the dividend as her income, she requires current value of $683,333.33.
*Study
PV, begin = (50000/0.06)+50000 = $883,333.33. She needs to accumulate present value of $683,333.33.
PV, begin = (50000/0.07)+50000 =$764,285.71. She needs to accumulate present value of $564,285.71.
PV, begin = (50000/0.08)+50000 =$675,000.00. She needs to accumulate present value of $475,000.00.
PV, begin = (50000/0.09)+50000 =$605,555.56. She needs to accumulate present value of $405,555.56.
PV, begin = (50000/0.1)+50000 = $550,000.00. She needs to accumulate present value of $350,000.00.

Note: her annual income is $120,000 with 19.32% saving ratio from cashflow/net worth analysis.

Diverted original posting from my facebook note dated 8-Nov-09.