Step : Determining the number of years you have until retirement: RBy Chris Gan etirement can be a rewarding phase in a person s life, which is why so many people today want to retire early. Some of us only plan to work until they are years old, and then spend the rest of their life on the beach, or just traveling round the world. Of course, the ability to retire early would depend upon how much money we can successfully set aside (during our working years) and this would normally depend on how well we have planned for our retirement. It is important to engage in basic retirement planning throughout our working lives and update those plans periodically, especially when our situation change financially or otherwise. While it is never too late to plan for retirement, starting early helps to avoid any unnecessary stress. In order to save for the future, there is of course that trade-off between spending and saving. For example, if we spend lavishly, buying an expensive sports car, a high-end hi-fi system or overseas holidays now, then we may not have much left in the bank account when they retire. Unless of course, we have managed to set aside some money through making the necessary investments, or have other forms of compulsory savings, which would be enough to provide us with a comfortable lifestyle when we retire. Most people in Malaysia find it difficult to estimate how much money they would need to save for their retirement, and thus usually ignore it. This article is designed to help you work through, step-by-step how much you really need to retire comfortably. The examples are simple and straightforward, and all the necessary steps using a financial calculator (both the popular the Casio FC00 and Hewlett Packard 7BII) are clearly illustrated. Seven easy steps to work out how much money you need The first thing you need to do is to determine, how long you have to achieve your retirement plans. In order words, how many more years until your retirement this can be when you plan to retire (for instance, at age ), or must retire (for example, age in the civil service), less your current age. Let s take an example of James who is now years old and plans to retire at age. The number of years to his retirement would be: Planned age to retire : years Less present age : years Equals number of years to retirement : years. Step : Determining your desired retirement income: The next step would require you to ascertain how much money you would when you retire, and no longer working. This is difficult to predict but is not impossible. You can estimate this by considering changes you plan to make to your spending patterns and how (and where) you plan to live, after you retire. Some of your expenses will probably be lower, for example, work-related expenses (like fuel or bus fare), clothing expenses and housing expenses. On the other hand, some other expenses may increase: for example, your travel expenses since you may have more free time. At the same time, your medical expenses may also increase as you get older, and become more susceptible to illnesses. It is often suggested that you would need about 0 percent to 70 percent of your last drawn annual income after you retire. In our example, let s assume that James last drawn income is RM00,000 per year: As such, his desired annual income upon retirement would be RM0,000 (that is, 0 percent of RM00,000), calculated as: 0. X RM00, 000 = RM0,000 Once we have done this, we will need to estimate how long this retirement income would be needed. The number of years this income is required is a function of how long you would expect to live. In Malaysia, according to the latest information from the Statistics Department, the average life expectancy is 70 years for males, and 7 for females. Let s assume that James expects that he will live
until he is 80 years old, and as such he would need years of retirement income (from age onwards). Step : Calculating your inflation-adjusted retirement income Inflation is one of the most important factors to consider in retirement planning. It erodes the purchasing power of our retirement savings, and thus needs to be taken into account in our planning. Here we need to determine how much your retirement income would be, adjusted for inflation. PVA = RM87,000 x PVIFA ( yrs, %) = R87,000 x 7. = RM,78,8 PVA = Present value of annuity; PVIFA = Present value interest factor of annuity (see Table ). needed for retirement in the future, next we need to determine the total funds needed, so that we can plan appropriately towards achieving this goal. Inflation rate in Malaysia (990-00) Rate (%) 0 990 99 99 99 99 99 99 997 998 999 000 00 Year % In our example, we know that the current value of James retirement income is RM0, 000 (from Step ), and he has years before he retires (from Step ). The average inflation rate in Malaysia (from 990 to 00) is. percent - see chart below. Let us assume that the average inflation rate over the next years will be percent per annum. A retirement income of RM0, 000 today at an average inflation rate of percent would require James to have an inflation-adjusted income of RM87, 0 per annum in years time. This can be calculated as: FV = RM0,000 x FVIF ( yrs, %) = RM0,000 x. = RM87,000 FV = Future value; FVIF = Future value interest factor (see Table ). Step : Calculating the total funds needed at retirement After we have ascertained the inflation-adjusted income Let s assume that the average rate of return (on our investments) that we can expect for the next years until retirement would be 8 percent. As such, the real rate of return from our savings (given that inflation is percent) will therefore be percent (that is, 8 percent minus percent). In our example, given that James inflation-adjusted income at retirement equals RM87,0 per annum (determined in Step ), the total funds he would need can be calculated as above. Hence, the total fund needed when he retires, years from today would be approximately RM,78,8. Step : Estimating funds available at retirement The following step is to estimate the funds that will be available when we retire. Again, this amount is difficult to determine accurately and would depend on various factors such as the type of assets we have today, and those that we will accumulate in the future. Some of the sources of funds would include our EPF savings, personal compulsory savings, insurance cash values, and financial assets such as stocks and unit trusts, which can be disposed of.
To simplify our analysis, let s assume that in James case, his available funds amount to RM,000,000 (accumulated from various sources) when he retires. Step : Calculating the shortage (or surplus) of funds at retirement Once we have determined the total funds we require, and also the funds available at retirement, we can then plan for any possible shortfall. Total funds we require (from Step ) : RM,78,8 Total funds available (from Step ) : RM,000,000 Total shortfall : (RM,78,8) Step 7: Calculating the savings required to cover shortfall Next, to meet the shortfall at retirement which we have identified in the previous step, we need to calculate how much we must save during our working lives. For James, we know that: His total shortfall : (RM,78,8) No. of years to retirement : years Average rate of return : 8 percent PMT = (RM,78,8) / FVIFA ( yrs, 8%) PMT = (RM,78,8)/.7 = RM,000 PMT = Periodic payment (annuity); FVIFA = Future value interest factor of annuity (see Table ). Therefore, the amount that he would need to save in order to meet the shortfall (which is equivalent to an annuity), can be calculated as above. Hence, in our example, James would need to save a total of RM,000 per annum (or roughly RM.7 per month), in order to meet his shortfall target. We have demonstrated above how you can easily determine how much money you really need to retire, taking into account important factors such as inflation and the rate of return on your investments. The step-by-step process is intuitive, and allows you to estimate how much you need to save in order to build up your retirement fund. This will thus, allow you to plan accordingly to achieve your retirement goals. UT Summary of Retirement Planning Process Step : Determine when you plan to retire Step : Determine your desired retirement income Step : Calculate inflation-adjusted retirement income Step : Calculate funds needed at retirement Step : Project funds available at retirement Step : Calculate surplus/(shortage) of fund at retirement Step 7: Calculate savings required to cover shortfall
Retirement Planning Worksheet NAME: AGE: A Calculations Step : Determine when you plan to retire Planned retirement age: No. of years to retirement: B B - A = C Step : Determine your desired retirement income Desired monthly income (RM): Annual income (RM): No. of years income required (from retirement): D D x = E F Step : Calculate inflation-adjusted retirement income Assumed average inflation rate (%): Inflation adjusted-income (RM): G% FV = E x FVIF (C yrs, G %) Step : Calculate funds needed at retirement Inflation adjusted income at retirement (RM): Rate of return (%): Net return earned (less inflation): Total funds needed at retirement: FV H% H - G = I% PVA = FV x PVIFA (F yrs, I %) Step : Project funds available at retirement (RM) EPF: Savings: Insurance (cash value): Stocks/shares/Bonds/Unit trusts: Total: J Step : Calculate surplus/(shortage) of fund at retirement Total fund required (step ) (RM): Total fund projected at retirement (step ) (RM): Total surplus/(shortage) of funds (RM): PVA J PVA - J = K Step 7: Calculate savings required to cover shortfall Total shortage (RM): Savings required per annum (RM): Savings per month (RM) K PMT = K / FVIFA (C yrs, H %) PMT /
Keystroke-by-keystroke using Casio FC00 & Hewlett Packard HP7BII Casio FC00 Financial Consultant (for the James example) In Mode, Fin Step Step Step Step Step & Step 7 To calculate lump sum today Operations, -,, = 0., x, 00 000 = 0 000, +/- PV, N, i% COMP, FV Min, Shift, AC MR, +/- PMT, N, i% COMP, PV -, 000 000, = Min Shift, AC MR, +/- FV, N 8, i% COMP, PMT,, = Shift, AC MR, +/- FV, N 8, i% COMP, PV Display 0 000 Enter as present value 87 0.99 To store value in memory To recall stored in memory Enter as annuity 79 09.99 79 09.99 To store new value in memory To recall stored in memory Enter as future value 00.0 (savings per year) 7.00 (savings per month) To recall stored in memory Enter as future value 89. Hewlett Packard 7BII (for James example). Keystrokes Select FIN menu Select TVM menu Select OTHER, P/YR Select END Display Description To select Menu Annual compounding End of period payment
., -, = Step N Enter number of years to retire. 0., X, 00 000, = 0 000 Step +/-, PV Stores as present value, I%YR FV 87 0.99 Step : Compute inflation adjusted income. STO, Stores value in memory Shift, Clear Data. RCL, - 87 0.99 Step : Recall value stored in memory +/-, PMT Enter as annuity, N, I%YR PV 79 09.99 Compute total funds needed. -, 000 000 79 09.99 Step & : Minus savings STO, Store new value in memory Shift, Clear Data 7. RCL, - 79 09 Step 7: Recall value in memory +/-, FV Enter as future value, N 8, I%YR PMT 00.0 Compute savings per year,, = 7.00 Compute savings per month 8. Shift, Clear Data To calculate lump sum today Go through Step 7 above, Select PV instead of PMT 89. Table : Future Value Interest Factor (FVIF) % % % % % % 7% 8% 9% 0%.000.000.000.000.000.000.0700.0800.0900.000.00.00.009.08.0..9..88.00.00.0.097.9.7.90.0.97.90.0.00.08..99...08.0...00.0.9.7.7.8.0.9.8.0.0..9..0.8.007.89.77.77 7.07.87.99.9.07.0.08.78.880.987 8.089.77.8.8.77.98.78.809.99. 9.097.9.08...89.88.9990.79.79 0.0.90.9.80.89.7908.97.89.7.97.7..8.9.70.898.09..80.8 continues on page 0
7 7 8 9 0 7 8 9 0 % 0.990.970.90.900.8.79.78 7.7 8.0 9.7 0.7..7.007.8.779..98 7.0 8.0.0 % 0.980.9.889.8077.7.0.70 7. 8. 8.98 9.788 0.7.8.0.89.777.99.990.78. 9. % 0.9709.9.88.77.797.7.0 7.097 7.78 8.0 9. 9.90 0.0.9.979...7.8.877 7. % 0.9.88.77.99.8..00.77 7. 8.09 8.70 9.8 9.98 0..8..7.9.9.90. % 0.9.89.7.0.9.077.78. 7.078 7.77 8.0 8.8 9.9 9.898 0.797 0.878.7.89.08..099 % 0.9.8.70...97.8.098.807 7.0 7.889 8.88 8.87 9.90 9.7 0.09 0.77 0.87.8.99.78 7% 0.9.8080..87.00.7.89.97. 7.0 7.987 7.97 8.77 8.7 9.079 9. 9.7 0.09 0. 0.90. 8% 0.99.78.77..997.9.0.7.9.70 7.90 7. 7.908 8. 8.9 8.8 9. 9.79 9.0 9.88 0.78 9% 0.97.79..97.8897.89.00.8.99.77.80 7.07 7.89 7.78 8.007 8. 8. 8.7 8.90 9.8 9.8 0% 0.909.7.89.99.7908..88.9.790..9.87 7.0 7.7 7.0 7.87 8.0 8.0 8.9 8. 9.0770 Table : Present Value Interest Factor of Annuity (PVIFA) 7 8 9 0 0 0 0.8.8.9.0.7.8.9.08.0.8.78..889.8..8.9.9.9.78.00.8.8.89.0.8.9999.080.79.9.8.8..80.07.8.70.7.80.098.7.89.0.78.89.00..77.8009.870.979.08.08.9.8..9.800.8 7.07.799.88.9799.0789.89.90.0.70..8.9.0 7.000 8.980.7.0.9.09.9.0.98.8.0.07.99.7 7.8 0.87.7 8.0..098.78.790.9.88.799..897.7 7. 0.7.97.00 9.70.8.79.97.7.9.7000.990.7.0.88 0.07.78.7.90.90.87.08.7..970.7.77.7.0 8..77 0.0.09 8.7 7.7.8..797.77.90.0.99.9.77 0.87 7.9 8.0.9 7.890 7.909 Table : Future Value Interest Factor (FVIF) from page 9
0.8077.9 9.00 7.90.7.78.090.78 0.77 9.9 9.08.998.87 8..7.98.977. 0.8 9. 0.87 7..8 9.798 7.9.0.7.9 0.77 9.779.09 9.90.87 0.700 7.77.8.0.08 0.88 9.88 0 9.9..798.8 8.9.79.8007. 0.97 9.98 Table : Future Value Interest Factor of Annuity (FVIFA) % % % % % % 7% 8% 9% 0%.000.000.000.000.000.000.0700.0800.0900.000.00.00.0909...8.9..78.00.00..8..0.7.99.0.7.0.00.00.09...7.707.8.987.0.0.08.8.0.809.97 7. 7.9 7. 7.7 7 7. 7. 7. 7.898 8.0 8.98 8.0 8.98 9.00 9.87 8 8.87 8.80 8.89 9. 9.9 9.897 0.98 0..08.9 9 9.8 9.7 0.9 0.88.0.9.9780.87.00.79 0 0. 0.997.9.00.779.808.8.8.99.97.8.87.8078.8.08.97.78. 7.0 8..8..90.08.97.899 7.888 8.977 0.07.8.809.80.78.8 7.70 8.88 0.0.9.9.7.97.979 7.08 8.99 9.98.0.0.9.09 7.970.099 7.9 8.989 0.0.78.70.90 7. 9.09.77 7.79 8.9 0.9.8.7.7 7.888 0..00.997 7 8.0 0.0.7.97.80 8.9 0.80.70.977 0.7 8 9.7... 8. 0.907.9990 7.0.0.99 9 0.809.80.9 7.7 0.90.700 7.790..08.9 0.090.97.870 9.778.00.78 0.99.70.0 7.70 8..00.9.9 7.77.8.90 7.09 8.7009 98.7 0.789 0.8 7.7.089.88 79.08 9.08.8.07.90.0 9.99 0. 7. 90.0.8 8.9 7.8.708 7.0 0 8.88 0.00 7.0 9.0 0.7998.70 99. 9.0 7.88.9.8 7.897 9.799.09 9.700.7 8.79 8.0.887 78.908 0. 8.79.799.7 09.80 90.9 0.89 7.770 8.08.908 Chris Gan is a senior manager with a unit trust company. He has worked as a business consultant and has lectured at universities in Malaysia and New Zealand. Previously, a regular contributor to Personal Money magazine, he is also the author of Ringgit & Sense: The Guide to Smart Investing. 8