A retirement plan is important to develop in advance because of the benefits to individuals, businesses, and employees. It allows investing in financial security when some of the employees retire (IRS, 2022). Mr. and Mrs. J have been married for thirty years and have built a small business together that is the source of their income. The clients note that they are in good health and would like to dedicate their time to being retired to themselves, such as engaging in more physical activity and traveling the country.
Factors to Consider
When choosing an appropriate retirement plan, it is necessary to consider several factors regarding clients. Mr. J is turning fifty-two next year and would to retire by the age of sixty. Mrs. J is turning fifty next year and would like to retire the same year as her husband so that they have as much free time as they can together. The couple does not have any dependents per se; however, they have a twenty-one-year-old daughter who is building her career in IT and does not live with her parents. The spouses do not have parents or any older relatives or siblings for which they care.
In terms of health, the clients do not have any pressing current issues that must be considered in the retirement plan. Mr. J is in good health and attends regular check-ups with his family physician, while Mrs. J has been in remission for ten years after surviving breast cancer. After Mrs. J’s illness, the couple decided to take their health seriously and invest in a complete insurance package as a way to guarantee preventive health care. Based on the latest data by the US Department of Health and Human Services, in 2020, life expectancy at birth for males was 75.1 years, while for females, it was 80.5 years (Arias et al., 2021). Considering these statistics, it is expected that Mr. J will live at least fifteen years after his retirement while Mrs. J will live at least twenty. Therefore, the retirement plan allocated for the spouses should be such to cover their potential expenses over the course of twenty years.
Desired Age of Retirement and Retirement Income
The desired age of retirement for Mr. J is sixty years old, and for Mrs. J, it will be fifty-eight because they both agree to retire at the same time and delegate all of their leadership and management responsibilities related to their business. The clients’ desired age of retirement is conducive to the development of a plan that considers new income revenues as well as building on the revenue stream that the couple has been developing for decades.
Regarding the desired retirement income, the optimum amount is usually between 70% and 80% of the pre-retirement income for maintaining the standards of living that the clients used to have before retiring (Plummer, 2021). Mr. J and Mrs. J’s combined income from their business averages around $85,000 per year ($7,080 per month). Drawing from the formula for a good retirement income and taking the highest percentage of 80%, the recommended retirement yearly income of the couple is $68,000 ($5,666 per month) (refer to Appendix B). This amount is determined based on the fact that the clients want to maintain their regular lifestyle without compromising on its quality. However, the amount is expected to increase as clients develop a list of things they want to do during their time on retirement. Any travel and hobbies expenses should be accounted for, which is why it may be needed to increase the desired income to at least $75,000 a year in the future.
Clients’ Personal Risk Tolerance
Risk tolerance represents the level of risk an investor is willing to take; however, gauging one’s individual tolerance to risks depends on several factors (Liu et al., 2022). Notably, taking into account the clients’ age, their investment horizon is shorter compared to that of younger individuals, while it is not as short as among individuals of older age. Before Mr. and Mrs. J retire, their risk tolerance will be considered on a moderate level because they are business owners and have some funds allocated to handle unexpected situations.
Besides, the client’s risk tolerance is considered moderate because the funds for retirement are not needed right away, and there are at least eight years for the couple to set aside a considerable amount of funds to add to their already existing savings (refer to Appendix A). Because Mr. and Mrs. J have a business that offers them a steady income, their risk tolerance is higher than in other retiring couples who have worked for an employer throughout their lifetime. Due to their substantial network, they do not have to make risky investments such as futures and options despite the appeal of quick and large profits.
To maintain the clients’ risk tolerance on a high to moderate level, it is recommended to spread their risks to decrease their exposure to a single investment. Therefore, despite having a steady source of income in the form of their business, the clients should diversify their income streams; for example, by investing in funds for regular dividend income such as the Columbia Dividend Opportunity Fund (INUTX), the Federated Strategic Value Dividend Fund (SVAAX), the T. Rowe Price Dividend Growth Fund (PRDGX), or others. The key objective for the clients is ensuring that their income sources are diversified without investing in high-risk streams.
Personal Retirement Plan
Mr. and Mrs. J note that they have been following the 401(k) plan up to now to address the concerns regarding their retirement. It is a plan that many self-employed individuals choose it because it is for businesses whose only eligible participants in the plan are their owners and spouses (IRS, 2021). The plan is a perfect fit for the couple because one of the spouses will be considered the owner of the business while the second spouse is regarded as an employee, thus allowing them to adopt the solo 401(k). Up to now, the couple has been contributing around 15% of their shared income to their retirement account as employers, but it is recommended to increase the percentage to 25% over the course of the next eight years to maximize on their savings counting years up to the retirement and meet the maximum of the net adjusted self-employed income. When contributing to the solo 401(k) as employees of the business, the maximum contribution about for individuals 50 and older is $27,000 based on 2022 data, which means that the total amount will vary from one year to another (Ashford, 2022). Overall, because the 401(k) model allows for making catch-up contributions to persons who are older than 50, the plan is the ideal fit for the couple so that they may maximize their savings allocated for retirement.
Besides to the mentioned benefits of the 401(k) retirement plan for the client couple, it offers an advantage when it comes to taxes. Notably, when the clients contribute to the plan, they can reduce their taxable income, thus cutting down the tax bill. Therefore, any money that the clients will invest will grow tax-deferred until their retirement, while the withdrawals they make in retirement are taxed as regular income. Finally, the solo 401(k) plan allows one to take loans from it if necessary, such as for emergencies.
Asset Allocation for Risk Mitigation
Asset allocation represents a foundational component of the retirement plan and is concerned with deciding how much of the available portfolio will be allocated to devote to various asset classes. The traditional categories of assets include equities (stocks), fixed income, and cash equivalents, while the remaining types of investments, such as property or commodities, fall under the category of alternative investments.
The clients reported having a $40,000 portfolio that they can invest in a timeframe of eight years before they retire. The asset allocation recommended for the couple is 50%, which is $20,000, allocated for stocks, which can be further differentiated into domestic, emerging, and international markets, as well as smaller and larger caps (refer to Appendix C). In addition, 40% of the portfolio, which is $16,000, should be allocated for the combination of government and high-yield bonds, while 10%, which is $4,000, should remain in cash equivalents. Such diversification of the client’s portfolio allows for fair risk control without compromising on growth potential. Because Mr. and Mrs. J do not have a long time horizon, they cannot afford to take risks and be more aggressive with their investment portfolio.
References
Arias, E., Tejada-Vera, B., & Ahman, F. (2021). Provisional life expectancy estimates for January through June, 2020. NVSS.
Ashford, K. (2022). Are you self-employed? Check out a solo 401(k). Forbes. Web.
IRS. (2021). Retirement plans for self-employed people. Web.
IRS. (2022). Benefits of setting up a retirement plan. Web.
Liu, J., Cheng, Y., Li, X., & Sriboonchitta, S. (2022). The role of risk forecast and risk tolerance in portfolio management: A case study of the Chinese financial sector. Axioms, 11, 1-19.
Plummer, S. (2021). What is a good monthly retirement income? Web.
Appendices
Appendix A
Table 1. Annual and monthly savings before retirement (excluding 401(k))
Appendix B
Table 2. Annual and monthly withdrawals after retirement
Appendix C
Table 3. Asset allocation over the life of the plan