PART OF SPENDING WISELY involves making a judgment call as to how much to save for emergencies, for funding the education of children and for funding retirement. Today we consider scenarios for funding retirement.
They are as follows:
1. A 24-year-old woman decides to save $200 per month towards her retirement at age 65 years.
2. A 34-year-old man decides to save $300 per month towards his retirement at 65 years old.
3. A 49-year-old man decides to save $500 per month towards his retirement at 65 years old.
Assuming that the saved funds are invested and earn an annual return of five per cent per annum compounded for each full year of saving, and treating each full year of saving as an annual annuity, the relevant multiplier factors can be taken for the annuity future value table. For example, for Scenario 1, the annual annuity would be $2 400 ($200 x 12) which would have been invested for 40 years plus the funds accumulated in the last year. The present value factor in this case is 120.8.
Thus the fund accumulated by retirement for Scenario 1 would be approximately $292 320 ($2 400 x 120.8 + 2 400).
For Scenario 2, the annuity is $3 600 and the period is 30 years. The relevant future value factor is 66.4. This fund would have accumulated $242 640 ($3 600 x 66.4 + $3 600)
For Scenario 3, the annuity is $6 000 and the period is 15 years. The future value factor in this case is 21.6. This fund would have accumulated $135 600 ($6 000 x 21.6 + $6 000).
Although Scenario 1 has the lowest annuity amount, it provides the largest retirement fund balance. This is the result of having the compound interest effect over the longest period. The scenarios underscore the point that the earlier one starts retirement funding, even with a modest yet regular amount, the better.
Another key point that arises is the amount of pension annuity these funds would be able to buy for the next 15 years after retirement, assuming a discount rate of four per cent. From the present value annuity tables, the factor is 11.12. Thus:
The $292 320 fund of Scenario 1 would purchase a pension annuity of approximately $2 110 per month (292 320/11.12/12).
The $242 640 fund of Scenario 2 would purchase a pension annuity of approximately $1 818 per month (242 640/11.12/12).
The $135 600 fund of Scenario 3 would purchase a pension annuity of approximately $1 116 per month (135 600/11.12/12).
The pension annuity of Scenario 1 provides a more valuable one compared with the level of saving in building the pension fund ($2 110 pension versus savings of $2 400 per month). The comparisons for the other scenarios are much lower.
This can be emphasised in a different way: where one may delay retirement funding until earnings are higher, making it more comfortable to save a larger amount like saving the $500 per month in Scenario 3, it is better by far to start with a modest but regular amount earlier which can be augmented over the years when there are increases in wages and/or promotions.   Â
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. She can be contacted at louisefairsave@nationnews.com. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
