CFP - Retirement Savings and Income Planning (18% of the exam) - Section F.44

Retirement needs analysis

Projecting retirement income need with replacement ratios or expense budgets, inflation and longevity assumptions, computing the capital required and the periodic savings to reach it, and stress-testing the plan against sequence-of-returns risk. Items require the calculation and its planning implication.

Retirement capital needs analysis

Practice question for this objective

Free sampleRetirement Savings and Income Planninghard

Marcus is 50, earns a gross salary of 160,000 dollars a year and intends to retire at 65, which is 15 years away. His planner uses a wage replacement ratio of 75 percent of gross salary and assumes salaries and prices both rise at 3 percent a year. Social Security is expected to provide 42,000 dollars a year from age 65, stated in today's purchasing power, and that benefit will also have risen with inflation by the time he claims it. The remainder of the income is to come from his portfolio. What first year portfolio withdrawal must the plan fund at age 65, expressed in the dollars of that year?

AAbout 121,521 dollars, the shortfall in today's money inflated at 3 percent for the 15 years to age 65 Correct
BAbout 78,000 dollars, the shortfall measured in today's purchasing power at the date of the analysis
CAbout 144,956 dollars, the inflated replacement need less the Social Security figure stated in today's money
DAbout 186,956 dollars, the whole replacement income inflated for the 15 years to age 65

Inflate the retirement income shortfall, and every element of it, to the retirement date before sizing the portfolio that funds the first withdrawal. Work in today's money first, then inflate once. The replacement need is 160,000 times 0.75, which is 120,000 dollars a year in today's purchasing power. Social Security supplies 42,000 dollars of that in the same purchasing power, so the portfolio must supply 78,000 dollars a year in today's money. The first withdrawal happens 15 years from now, so it is inflated by 1.03 raised to the power 15, which is 1.557967. Multiplying 78,000 by 1.557967 gives about 121,521 dollars. Because the Social Security benefit is also indexed, subtracting it in today's money before inflating gives the same answer as inflating both figures separately, and it avoids the error of mixing a future amount with a present one.

Why A is correct: The replacement need is 120,000 dollars and Social Security meets 42,000 dollars of it, leaving a 78,000 dollar shortfall in today's money that is then inflated over the 15 years to retirement.

Why B is wrong: This is the correct shortfall but it is left in today's money; the withdrawal is taken 15 years from now, so it must be inflated to the retirement date before the capital sum is calculated.

Why C is wrong: This inflates the 120,000 dollar replacement need correctly but then subtracts a Social Security benefit that has been left in today's dollars, so a future amount is reduced by a present one and the shortfall is overstated.

Why D is wrong: This inflates the full 120,000 dollar income need and ignores Social Security altogether, so the portfolio is asked to fund income that another source is already providing.

See more CFP practice questions, answers explained.

Exam traps in Retirement Savings and Income Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

Roll the balance to the individual retirement account now, because the anti-alienation protection of the Employee Retirement Income Security Act follows the money into the account, so the decision turns on fees and fund range
Why it is wrong: The protection is a feature of the plan itself rather than of the money inside it, so it does not travel with a rollover; treating the two vehicles as equivalent is the error the rest of the analysis depends on.
About 77.5 percent, removing the payroll taxes, the plan deferrals and the work costs and nothing further
Why it is wrong: All three of the amounts that cease are removed correctly, but the 6,000 dollars of extra health cover that begins at retirement is never added back, so the ratio understates what Ravi will actually have to spend.
About 494,385 dollars, the same 1,200,000 dollars discounted for 30 years at the 3 percent rate
Why it is wrong: This discounts a nominal target using the inflation rate rather than the portfolio's earning rate, and the inflation-adjusted rate belongs in the income calculation, not in the discounting of a fixed future sum.

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