Type of Assumptions Used For Retirement Planning

In retirement planning, there are a number of assumptions that I will  needs to take into consideration as these assumptions will have an impact on the final plan to be recommended to my clients. The assumptions can be grouped into two categories: Qualitative Assumptions & Quantitative Assumptions

Qualitative Assumptions

Qualitative assumptions refer to the type of lifestyle that a client wishes to have upon his retirement. The common assumptions include:

• whether to continue working
• whether to downgrade to a smaller house or to sell the current house and rent one instead
• whether to pursues expensive hobbies such as golf
• whether to migrate to another country

Notice that the answers to each of the above questions will affect the amount of funds required to support the client after his retirement.Quantitative Assumptions

Quantitative assumptions are just as important and no easy to make. It is thus important that you understand their impact on the financial plan as your client may need your advice. The common quantitative assumptions include:

• inflation rate
• investment rate of return
• income tax rate
• replacement ratio percentage
• expected retirement age
• years to retirement
• life expectancy

Inflation Rate

Inflation erodes the client’s purchasing power. As such, under-estimating the inflation rate will result in the client being unable to maintain economic self-sufficiency during retirement. In retirement planning, you must understand the impact of inflation on your financial plan, for example using a 4% inflation rate and compare to a 6% inflation rate, the amount of funds needed for retiremement can actually increases by 20%.

Investment Rate Of Return

As with inflation rate, hisotrical data should be used to estimate the annualised investment rate of return. Inflation-adjusted returns should be used and depending on the tax aspects, either before tax or after tax rates of return should be used. Therefore, you have to estimate different rates for the different asset classes. You may use an average rate for the various classes of assets if it alright with your client.

Income Tax Rate 

Tax rates are subject to revision. Since it is impossible to predict what the tax rates will be in the future, one solution is to use your current year effective rate for both the pre-retirement and retirement years. As chargeable income is likely to decrease after one’s retirement, such a funding method will over-state the tax impact and thus provide a cushion for the you.  Alternative, you may base on the before-tax inflation adjusted returns.

The Replacement Ration Percentage 

The replacement ratio percentage is used to determine how much my client will require on the first year of retirement. The usual estimate used is 70%  (80-85% for lower income) on their last drawn pay.

Expected Retirement Age 

As the current statutory retirement age is 65, most people will think that they will contiune to work until they reach the official retirement age. However, circumstances may force them to retire early. For example, if my client with poor health may decide to retire earlier and this will disrupt the financial plan as the accumulation period for building up the fund for retirement is shortened.

Years To Retirement

This period is derived by subtracting your current age from the desired retirement age. It is the period during which the you could accumulate the necessary funds for your retirement.

 Life Expectancy

According to the Ministry of Health’s Statistics, the life expectancy for a male is 78 years whilst that for a female is 80 years. As a rule of thumb, I wyould add another 8 years to them. Thus a man is presumed to live to age 86 whilst a woman is presumed to live to age 88, using this age to minus the desired retirement age will give the number of years that a person will live after he have retired.

For my clients who have poor family histories, I will base on their parents, grandparents, aunt and uncles’ age death to determine how long my client will live after their retirement. This is because medical studies have shown a strong correlation between genetics and life expectancy.

If you are doing your own retirement planning, please take note of these assumptions as a slight change in it will affect the accuracy of your retirement planning. If you will like us to assist you in your retirement planning, feel free to contact us and arrange for an appointment. E-Mail myself at jack@investmentsg.com

Good Luck!

Filed Under: Financial Planning • Retirement Planning

Tags: retirement assumptions • Retirement Planning