Problem 2 Retirement and Achieving Goals 

Leo Hon and Debbie Hinds have started to plan for retirement.  They are both 40 years old, working in good jobs, but also paying off a large mortgage that won’t be retired until they are 60.  Leo will get a modest retirement pension from a previous job, but neither of them has an employer plan now.  They would like to retire at age 60 when the mortgage is paid off.  Unlike Jairam, they do not like time value of money problems and they have not taken a personal finance course with the amazing personal finance professors at York University.  Instead, they go to financial planner Cheng Li for help.

Cheng discovers they each have $50,000 in an RRSP (i.e. $100,000 in total in RRSPs) and they each have $25,000 in a TFSA (i.e. $50,000 in total in TFSAs).  They plan to deposit $5,000 each ($10,000 in total) into their RRSPs every year until they retire.  They are disciplined enough that they will deposit the tax refund into their TFSAs.  Cheng discusses investment risk with them.  The long run expectation for the investments they have now is 4% real return per annum after all investment management expenses.  This is a moderately risky portfolio and he believes it matches their personal risk tolerance.

Cheng works out a retirement budget with them that indicates a need for $100,000 annual income before-tax when they are retired.  He projects their CPP, OAS and Leo’s previous employer pension and finds they will get about $50,000 p.a. starting age 60.  They come from long-lived families and want to plan to live to age 95.  They want to continue to live in the same house.  

All the cash flows are in real dollars.  Their marginal tax rate now is 40%.  Cheng estimates the average tax rate in retirement will be 20%.

Required

a) Cheng suspects that their plan will not reach their goal, and when he calculates the values at their age 60 he finds a significant shortfall.  How much is the shortfall?

b) Cheng suggests three ways for them to reduce or eliminate the shortfall.  What are his suggestions?

c) Pick one of the three suggestions in part b) and show numerically how they could reduce the shortfall.  You might be able to calculate this precisely, or you may only be able to show that you get closer to the goal, or overshoot it somewhat.  As long as you are calculating appropriately, a perfect match is not required.