Reference no: EM133001151
Case Study
Salary Sacrifice to Achieve an Accumulation Target
Ferda is an engineer who likes precision in everything she does. Ferda is 55 years old and wants to retire in 10 years. She has been doing some reading about retirement incomes. If Ferda was 65 years old today and was to retire today she has calculated that she would require $587,574 to afford the type of income stream she desires in retirement. However, Ferda is 55 years old, not 65 - she has 10 years to accumulate this amount. Ferda also knows that inflation over the next 10 years will mean that she will need to accumulate more than $587,574.
Ferda has worked out that $789,650 received 10 years from today has the same value as $587,574 today assuming an inflation rate of 3% p.a.
As her financial adviser, you explain that the broad scope of the assumptions which underpin such modelling mean that such precision is very difficult to achieve. Nonetheless, any plan is better than no plan even if it is necessary to come back to the plan from time to time and adjust the assumptions.
Ferda wants you to build a model which accumulates a nominal $789,650 in superannuation over the next 10 years. She has supplied you with the following information and assumptions.
- Her opening superannuation balance is $367,823.
- Her income is $70,000 p.a. and will grow in nominal terms by 4% per year.
- Her investment choice inside her fund is expected to earn 6% nominal returns p.a. after fees but before taxes.
- Her employer contributes an amount equal to 12% of her income to superannuation.
To make the modelling simpler, we will model in calendar years and assume that contributions are made in December each year so that they do not attract investment earnings in the current year.
The missing variable is the percentage of salary sacrificed into superannuation. Ferda is happy to sacrifice as much as possible to achieve her goal provided she stays within her concessional contribution limit. Ferda uses spreadsheets a lot in her work and has found the GOALSEEK function very useful in trying to solve problems like this. Construct a model similar to figure 8.6 and answer the following questions.
1. What percentage of her salary must Ferda sacrifice into superannuation in order to accumulate $789,650 in nominal terms in 10 years?
2. Explain to Ferda how salary sacrificing represents a trade-off between current consumption and future consumption and the factors she should take into account in determining the appropriate level of salary sacrifice.
3. What other factors besides salary sacrificing might Ferda alter in order to achieve her accumulation goal?
4. If Ferda was 15 years from retirement rather than 10 years, would her goal of accumulating a real amount of $587,574 in superannuation alter if her desired retirement income stream remained the same? Would her goal of accumulating a nominal amount of $789,650 in superannuation alter?