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Retirement Planning (Part 4 of 8)

>> Saturday, February 20, 2010

Advances in medical science has resulted in people living longer. This increase in life expectancy makes retirement planning even more crucial. Furthermore, with better affluence, there is also an increase in demand for a better lifestyle during retirement.

The objective of retirement planning varies depending on circumstances, and normally includes:
- Maintaining a self sufficient pre-retirement standard of living
- Coping with increasing health care cost
- Protection of property and against personal liability
- Providing for dependents
- Estate planning

The process for retirement planning:
Step 1: Overcome Obstacles
Step 2: Determine Goals
Step 3: Measurement
Step 4: Reference Point
Step 5: Overall Plan

Overcoming The Road Blocks
There is only a limited period of accumulation and a continuous period of consumption. The first step is to overcome the many obstacles hindering retirement planning. These include spending beyond means, unprepared for unexpected expenses (like repairs), inadequate insurance (like property loss, medical bills), tapping into retirement funds for other purposes (like upgrading house, holidays), etc.
(1) Aim to save at least 10% of income and gradually increase it to 20% when it is nearer to retirement. This accumulates towards the retirement funds and helps to accustom to a retirement lifestyle within financial means.
(2) Establish an emergency fund of at least 6 months of income that is separate from the retirement planning fund. The will be used for risk retention, covering for unexpected expenses without drawing on the retirement funds.
(3) Have sufficient insurance.  A major crisis will be a huge drain on all of the savings, it is best to transfer this risk by being adequately covered.
(4) Saving for other specific purposes should be saved for separately. It will derail the retirement plans due to the shortfall.

Determine Retirement Goals
Depending on the circumstances, the goals will vary from individual to individual. Some common areas to consider:
(1) Lifestyle.
- Housing: Same house, mortgage remaining, upgrade, downgrade, migrate.
- Leisure: Pursuit of hobbies like golf, yoga, charity or religious activities.
- Travel: Overseas holidays, car ownership.
(2) Age of retirement.
- The last day to have to work or the last day to want to work.
- Early retirement due to corporate issues, health, care giving concerns, etc.
(3) Health.
- Coping with increasing health care cost.
- Health screening.
- Dental care.
(4) Estate planning.
- Passing on the wealth eventually.
(5) Caring for dependents.
- Physical or medical care for elderly parents.
- Providing for children not yet independent or siblings requiring aid.

Measuring The Finance Required
From the above goals, the required amount needs to be quantified.
(1) Lifestyle and dependent expenses. An estimate is about 60% of pre-retirement income.
(2) Project the retirement age. The statutory retirement age is 62 years old.
(3) Health expenses. Total up the amount of insurance premiums and health screening cost.

In addition, some assumptions need to be made:
(1) Inflation rate. The average historical inflation rate in Singapore is about 1.5%.
(2) Investment returns. Depending on the choice of investment, this varies significantly.
(3) Life expectancy. A reference will be the natural death ages of great-grandparents, grandparents or parents. The average age is 78 for males and 82 for females, and this average is increasing.

Reference Point
The current position needs to be analyzed so as to determine the strategies to achieve the goals.
(1) Current age. Number of years to accumulate funds before retirement.
(2) Current health. Deteriorating health will be more of an immediate concern.
(3) Financial position. Amount of savings, assets, liabilities, current income, expenses.
(4) Existing plans. CPF, SRS, insurance and investments already in place.

Overall Plan
Depending on which stage on the retirement plan, the approach to adopt will be different.
(1) Accumulation Period
The period when one starts to save for retirement until about 10 years prior to retirement.
The focus will be on the shortfall of funds required for retirement form the current reference point. The main strategy will be on saving to invest. Investment will be covered in a later topic.
(2) Transistion Period
The period about 10 years just prior to retirement.
As retirement draws nearer, the goals become clearer. It is important to review if the desired lifestyle can be achieved with the funds or if more savings is required. The funds accumulated earlier will also need to be gradually repositioned into less risky investments.
(3) Retirement Period
This continues throughout since retirement.
The funds will be used to generate current income. Some considerations during this period:
- Purchase of Annuities (CPF Life)
To provide a guaranteed income for life. Recommended to purchase to cover for the minimum monthly living expenses required.
- Maximize use of property
Reverse mortgage, downgrading, renting out spare rooms can be considered for additional income.
- Work
To perhaps work on a part time basis, as a consultant or run a business.

As with all plans, it will need to be continuously reviewed when personal circumstances change (like a newborn or divorce), external market conditions affecting investments, or introduction of new policies (like change of statutory retirement age or CPF rules).

Use of the Present Value and Future Value calculations covered earlier will need to be used to give a better estimate of the amount needed. A simple example:
John Doe in good health, age 40, intends to retire at age 60, current income is $60,000 annually.
Assumptions: Projected expenses at retirement is 60% of pre-retirement income, income will increase 3% annually, inflation is 2%, investment returns is 7%, life span will be till age 80, will carry on to stay at current residence. CPF contributions mainly used for housing and repayment of loan and has not started any retirement plans.
PV = 60,000, 1/Y = 3%, N = 60 - 40 = 20; FV = 108,367.
Therefore, pre-retirement income needed per year = 60% of FV = $65,020
PMT = 65,020, 1/Y = 7% - 2% = 5%, N = 80 - 60 = 20; PV = $810,293
Total retirement fund needed at point of retirement = $810,293
FV = 810,293, 1/Y = 7%, N = 60 - 40 = 20; PMT = 19,765
Amount needed to save per year is $19,765 or $1,647 per month.

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