Case Problem 12: Preparing Carolyn Bowen's Investment Plan

Case Problem12preparing Carolyn Bowens Investment Plancarolyn Bowe

Determine how much money Carolyn Bowens will have available at retirement, calculate her potential annual income from an annuity, assess her total retirement income under different scenarios, analyze whether she can meet her financial goals, and evaluate her investment plan's risk and return characteristics. Provide specific recommendations to improve her financial strategy.

Paper For Above instruction

Carolyn Bowen, at age 55, finds herself approaching retirement with limited financial resources but a clear goal of achieving a comfortable retirement lifestyle. Her situation encapsulates many themes in personal financial planning, including asset accumulation, risk management, and investment strategy. This paper provides a comprehensive analysis of her current financial position, projected retirement income, and the effectiveness of her investment plan, offering informed recommendations to optimize her retirement preparedness.

Introduction

Retirement planning is a critical aspect of personal finance, especially as individuals approach older age and evaluate their resources against their prospective needs. Carolyn Bowen’s case exemplifies a modest asset base, necessitating a strategic approach to investment and planning. Her current resources include life insurance proceeds, savings, and expected future income, all of which must be positioned effectively to meet her retirement goals. This analysis involves calculating her expected assets at retirement, determining sustainable income streams via annuities, and critically evaluating her investment choices and their associated risks.

Assets at Retirement: Determining the Future Value of Current Savings

Currently, Carolyn has $37,500 in savings, and she received $60,000 from her husband's life insurance. She plans to place her available resources into a bank account earning 6% interest compounded annually until retirement. Assuming she invests all current available funds, and ignoring additional contributions, her future value (FV) at retirement can be computed using the compound interest formula:

FV = PV × (1 + r)^n

Where PV = present value, r = annual interest rate, n = number of years until retirement.

For age 62 retirement: n = 7 years. For age 65: n = 10 years.

Calculations:

• At age 62:
• Initial funds = $60,000 (life insurance) + $37,500 (savings) = $97,500
• FV = $97,500 × (1 + 0.06)^7 ≈ $97,500 × 1.5036 ≈ $146,530
• Plus the sell proceeds from her house: $112,500 at age 62, combined total:
• Total resources at age 62 = FV + house sale proceeds = $146,530 + $112,500 ≈ $259,030
• At age 65:
• FV = $97,500 × (1 + 0.06)^10 ≈ $97,500 × 1.791 ≈ $174,567
• Total resources at age 65 = $174,567 + $127,500 ≈ $302,067

These figures represent her gross accumulated assets at the respective retirement ages once she liquidates her savings and house equity, providing a foundation for her income planning.

Estimating Annual Retirement Income from Annuities

Carolyn intends to convert her lump-sum assets into a stream of income via a single premium immediate annuity, with payout durations corresponding to her remaining lifespan from retirement age to her estimated age 80. The payout rates are provided:

• At age 62: $79 per $1,000 for 18 years
• At age 65: $89.94 per $1,000 for 15 years

Using these rates, her annual income from the annuity can be calculated:

• Retiring at 62: Income = (Total assets at retirement / 1,000) × 79
• Retiring at 65: Income = (Total assets at retirement / 1,000) × 89.94

Applying the figures:

• At age 62: (Approximately $259,030 / 1,000) × 79 ≈ 259.03 × 79 ≈ $20,460
• At age 65: (Approximately $302,067 / 1,000) × 89.94 ≈ 302.07 × 89.94 ≈ $27,179

This indicates that the initial lump sum, when converted into an annuity, would provide approximately $20,460 annually if retiring at 62, and about $27,179 if retiring at 65.

Assessing Total Retirement Income

To determine her total income, we add the income from Social Security, pension benefits, and the annuity:

• Retirement at 62:
• Social Security + pension = $16,308 annually
• From annuity = $20,460
• Total = $16,308 + $20,460 = $36,768 annually
• Retirement at 65:
• Social Security + pension = $20,256 annually
• From annuity = $27,179
• Total = $20,256 + $27,179 = $47,435 annually

Compared to her required annual expenditure of $45,000, her total income at age 62 narrowly meets her needs, whereas at age 65, she exceeds her requirement comfortably.

Implications for Retirement Planning

Given these calculations, retiring at age 65 appears more advantageous for Carolyn, providing a larger income buffer against unexpected expenses or inflation. Retiring at 62 limits her income to just above her needs but offers the benefit of earlier retirement. The key question is whether she values the additional years of retirement comfort versus the potential benefits of earlier retirement.

Investment Plan Evaluation: Risks and Return

Carolyn's plan to invest her available funds in a savings account earning 6% coupled with her annuity purchase offers a conservative yet predictable approach to retirement funding. The safety of the savings account aligns with her risk aversion, while the annuity provides a secure income stream. However, the plan assumes constant interest rates, stable annuity payout rates, and does not account for inflation or market fluctuations. The primary risks involve inflation eroding her real purchasing power and the potential for lower-than-expected returns on her savings.

While the approach guarantees a portion of her income, it may fall short if her expenses or inflation increase significantly, suggesting the need for portfolio diversification or inflation hedging strategies.

Recommendations for Enhancement

• Explore investments with inflation protection, such as Treasury Inflation-Protected Securities (TIPS).
• Consider gradual increases in savings or additional investment avenues, if feasible, to boost her retirement funds.
• Evaluate the cost and benefits of purchasing a longer-term annuity or a variable annuity that may offer growth potential with some guarantees.
• Seek professional financial advice to create a comprehensive estate and tax plan, maximizing her benefits and minimizing liabilities.

In conclusion, Carolyn's conservative strategy ensures a stable foundation for her retirement. However, strategizing for inflation and potential healthcare costs, and diversifying her investments, can significantly enhance her financial security. Her decision to retire at 65 aligns well with her needs, given her current resources and projected income streams. Nonetheless, ongoing review and adjustment of her plan are essential to adapt to changing circumstances and economic conditions.

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