Retirement Planning: How It Works
The lesson that can be gleaned from lizards is to stand still and run fast. Observing almost any survival creature, you see the simplicity of their impulse. Freeze, jump, run. What can financial planning teach about lizards? Stand still, observe, crack like a whip into action.
We’ve stood still long enough. So here and now, let’s stop talking about retirement planning, let me show you how it is done, fast and quick.
We have, for example, an employee (George) earning Php 51,200.00 per month. His monthly expenses are Php 33,400. For simplicity’s sake, let’s just say, George is single, so we can focus his finances on retirement only.
At 39 years old, his primary financial objective is to save for retirement by age 65. In an effort to stretch his savings during retirement as long as possible, we have determined the optimal numbers based on his current monthly salary. He can live with his retirement funds until age 77. He can leave at least P100,000 to his estate.
To live comfortably in retirement, the rule of thumb is for George to afford at least 75% of his current actual monthly expenses. To be safer, let’s give a bigger estimate by computing 80% to accommodate some emergency funds in his senior years. Using the highest monthly expense as a basis, George’s spends Php 50,150 for the month of December. Thus, 80% of his current monthly expenses would be Php 40,120, or an annual expense of Php 481,440. Assuming an inflation rate of 5% and computing the future value of Php 481,440, George’s retirement cost by the time he reaches 65 would be Php 1,711,843
Subsequently, George’s retirement costs at 66 years of age would be Php1,797,435; at 67, Php1,887,307, 68, Php1,981,672; and so on. By his final financial life age, at 77, his retirement cost will amount to Php 3,074,224.
To cope up with these costs, George has to set aside Php 27,000 at 39 and put it on an investment instrument or a life insurance policy (perhaps, a VUL) with at least a 7.5% rate of return. For the next 26 years, George has to set aside 10% of his annual income from this investment. Currently, his gross annual income is at Php 769,400. With a merit increase of 3% per year, his contributions to his retirement at age 40 should be Php 79,248 (or 10% of his gross income at age 40).
769,400 x 3% = Php 23,082
769,400 + 23,082 = 792,482
792,482 x 10% = Php 79,248.2
By age 41, George should contribute Php 81,626 and by 42, Php, 84,074, and so on.
Our assumption with George is that he would remain in his current employment until the age of 64. And that he would retire at age of 65.
As a private employee, the RA 7641 applies here. Based on this law, retirement pay will be computed using George’s gross annual income (Php 769,400), divided by the guaranteed months of pay (14), which gets us to 115,068.
Thereafter, 115,068, multiplied by the lump sum retirement factor of 1 and then multiplied by 34 [total number of years served or the sum of George’s years of current service (9) plus the number of years of service at the time she reaches 64 (25)].
When computed George’s Retirement Pay would be Php 3,912,314.
Do you follow so far?
By the time George retires before the age of 65, (with a net investment rate averaging 7.5% and a consistent 10% annual contribution) he would have saved Php 11,129,287 retirement fund.
[or Php 6,563,607 (fund balance as of age 63), plus Php 3,912,314 (retirement pay), plus 161,096 (contri-butions for age 64), plus Php 492,271 (interest of his investment from preceding year)].
6,563607 + 3,912,314 + 161,096 + 492,271 = 11,129,287
When asked how he would like to spend his retirement years, George explained that he will not stay completely retired. Knowing that retirement costs will eat away his savings, he understands that he would still need to earn some income during retirement. He plans to earn this through passive income, pension, and his business ventures.
Whatever the case may be, George wants to earn Php 475,000/year in retirement. Note, however, that the said Php 475,000 is based on his current estimation of his income today.
Therefore, twenty-six years from now, the Php 475,000 income should be valued at Php 1,024,381 by the time George reaches 65. This computation considered a 3% merit increase of current annual income.
The benchmark of success for George’s passive income and business ventures should earn him Php 1,024,381 (or Php 85,365/month) at 65 years of age. Then, at 66, his annual income should reach Php 1,055,112, and so on.
George plans to earn retirement income for a minimum of 11 years or until the age of 75.
George plans to leave a cash estate of Php 100,000, not considering inflation, to his family (again, this is in consideration that he is unmarried and without kids of his own). By the time of his death at 77, the Future Value of Php 100,000 using a 5% inflation rate would be Php 638,548.
Future Value = 100,000 x (1 + .05)38
FV = 100,000 x 6.385477
FV = 638,548
The table below shows George’s Fund Balance during his retirement years. The Fund Balance gradually depletes as retirement costs eat it away. Later, the cash estate is subtracted from it. By age 77, when all is said and done, George’s Fund Balance would be Php 10,974.
Of course, retirement is just one facet of financial planning. Computing together with the person’s other goals gets a little bit more complex, and it sure hell will bore you to death. But this is how retirement planning is basically done (not boring, I mean, but specific). Just remember your retirement costs, annual contributions, retirement pay, maintaining fund balance, retirement income, and estate, and you’re good to go.
If you need help with any of this, of course, you can just seek the good assistance of a financial planner who can, by all means, do this like a lizard. Freeze, jump and go into action.
You can also visit me at fb.com/marc.gutierrez.rfp for your financial planning needs.