Individual PM: 2011 AM Question 2A - Michael Becker Single Year Spending Need Ratio
Hey all - hope the studying is going well for everyone! Just a quick question from me that’s driving me nuts:
On the AM 2011 question 2A for the single year spending need ratio calc, why do we not include a final mortgage payment + a final salary in the investable asset base? Totally understand that they won’t be in the spending need cash flow (numerator) next year given that Becker pays off the mortgage, etc. but don’t understand why the asset base wouldn’t be impacted (denominator). Appreciate the help!
“Five years have passed. Robert Becker recently died and left his estate to his only child, Michael. Michael and his wife are both 50 years old and have no children. Michael expects to receive his after-tax inheritance of 8.0 million U.S. dollars (USD) at the end of this year. The Beckers both plan to retire at that time, and are meeting with Emily Frost to help them establish
an investment plan.
The Beckers currently do not have an investment portfolio and they own a home valued at
USD 3.7 million. At the end of this year, the Beckers’ outstanding debt will be USD 3.5 million
(home mortgage) and USD 150,000 (consumer debts). The Beckers will pay off their mortgage
and their consumer debts soon after the inheritance is received.
The Beckers currently have a combined after-tax salary of USD 475,000, current-year living
expenses of USD 250,000, plus annual mortgage payments (principal + interest) of
USD 225,000. Michael’s company pension will pay him USD 48,000 after-tax next year, and
then payments will grow at the rate of inflation, which is expected to be 3% annually. His
employer will continue to pay all of the Beckers’ medical costs until death. Both the pension and
health benefits will continue to accrue to Becker’s wife, if he dies first. The Beckers expect their
living expenses will also continue to grow at the rate of inflation until one of them dies. At that
time, they expect the survivor’s living expenses will decrease to 75% of their combined
expenses, and then continue to grow at the rate of inflation.
The Beckers intend to fund their living expenses with Michael’s pension and investment income
generated from their investable assets, which do not include their home. The Beckers consider
their investment base to be large, and want their portfolio to be invested conservatively. They
want to maintain the real value of their investable assets over time, and plan to leave their estate
to charity. All income and realized capital gains are taxed at 20%.
A. Calculate the after-tax nominal rate of return required for the Becker’s first year of retirement. Show your calculations.”
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