Modelling a retirement plan

How comfortable are you about your retirement? How much money will you actually need to safe for retirement and how do you know what you will receive once you retire? When it comes to retirement, proper planning is important. Unfortunately, there are many uncertainties associated with planning for the (long-term) future, including uncertainty about one's future earnings, the returns on the retirement fund and even legal or political changes. In this topic, we will go through a simplified example to show how someone can estimate the distribution of money after a certain number of years of saving for retirement. Including the uncertainties about your retirement money into a model like the one below can help you plan better for the good days to come!

Example

You are a 32 years old citizen of Country X and like to start planning your retirement. The retirement age in X is 60, but there is a 75% chance that it will be changed to 65 years. You contribute 5% of your salary to the retirement fund each year. Your annual salary this year is Ђ 20,000, and you expect it to rise Lognormal(3%,1%) per year in real terms (i.e. over inflation). You estimate that the return on the pension fund will be minimum 3%, most likely 4% and maximum 7% (assuming a Pert-distribution).

How much is your retirement fund worth upon retirement?

The file Finally retired provides the example of this problem. As you can see in the graph below, your total worth at your retirement age has a wide distribution, with a 90% confidence interval between Ђ 75,000 and Ђ 116,000. The left and right peaks represent respectively the situation in which the retirement age stays 60 years and the situation in which it increased to 65 years.

Of course, many other useful and interesting uncertainties can be added to the model and plenty of additional questions can be asked, but we leave that up to you!

Modelling a retirement plan

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