DETERMINING RETIREMENT NEEDS A CASE STUDY

1. DETERMINING RETIREMENT NEEDSA CASE STUDY Prepared by: Chan Ting, Choi Wang Chi Anny, Fong Fu Tak Simon Sum Pui Leong, Tao Kwok Lau Clement, Wong Chung Fai Joseph 4th June 2008

2. CONTENTS 1. OBJECTIVE OF THE STUDY 2. THE CASE OF MR. WONG 3. METHODOLOGY 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET 5. PROPOSED SOLUTION AND OTHER CONSIDERATIONS 6. CONCLUSION

3. 1. OBJECTIVE OF THE STUDY • To identify the retirement needs of an ordinary Hong Kong businessman using the theoretical framework originated from North America, with the objective of modifying the application for local planner.

4. 2. THE CASE OF MR. WONG • Mr. Wong’s Profile • Mr. Wong (age 48) is a Hong Kong citizen. He and his wife (age 45) own a small trading company. Mr. Wong as the major shareholder. He draws a monthly salary of HK$85,000 as managing director of the company. • They live in a 900 square feet flat in the Ho Man Tin area, purchased in 2003 at HK$4.8M with a car park included. With a 15 year mortgage, he pays a monthly installment of HK$20,000. • They have two children, daughter (age 17) and son (age 14) are both currently studying in USA with Mr. Wong’s younger sister who is a U.S. resident. She receives HK$20,000 each month from Mr. Wong for their tuition and living expenses.

5. 2. THE CASE OF MR. WONG • Mr. Wong’s parents are both retired; his father is 75 and mother 73 years old. They are living in a flat owned by Mr. Wong. The property is 675 square feet with an estimated value of approximately HK$2.8M. Mrs. Wong is a full time housewife and now concentrating in the caring of her mother (age 70) now. Her father died at age 60 because of brain tumor. • As Mr. Wong is the sole income source of the family, he has a term life insurance policy with coverage of HK$5 million for his liability. His trading company provides for medical insurance for the entirely family. • Apart from the two properties in Mong Kok and Ho Man Tin, Mr. Wong is maintaining a constant cash level of HK$200,000 in his savings account for contingency use. He also has equities with a net asset value of HK$300,000 as long-term investment. His current MPF balance is HK$265,000.

6. 2. THE CASE OF MR. WONG Summary of Mr. Wong’s Family Income and Expenditure * Assuming tax rate of 15%

7. 2. THE CASE OF MR. WONG • Mr. Wong’s retirement plan and expectation Mr. Wong plans to retire with financial security so that he and his wife can maintain the same lifestyle and living standard during his retirement. He has also indicated the importance of his children’s education and is prepared to support the children if they continue into postgraduate studies. As a business succession plan, he also intends to pass on his business to the children when he retires.

8. 3. METHODOLOGY • Step 1: Projecting retirement income from existing resources • Step 2: Comparing what Mr. Wong has to what he needs • Step 3: Providing inflation protection for income derived from existing resources • Step 4: Computer the sum needed at retirement • Step 5: Determining an annual savings amount to achieve the targeted amount

9. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Assumption (4Major): • Inflation Assumption • CPI (consumer price index) HK 1988-2007 rate 4.13% • Mr. Wong’s spending habit, medical and housing costs. • Due to appreciation of the renmenbi, imported goods from the mainland are becoming more expensive • Inflation rate – 4%

10. Consumer Price Index (Year-on-Year % Change) Average Consumer Price Index (1988-2007) = 4.13% Source: Census and Statistics Department

11. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Retirement Age Assumption • In HK official retirement age is 65. MPF funds and most old age benefits are available for Mr. Wong’s at 65 • As Mr. Wong is the owner of his business he can adjust/choose his retirement age with more flexibility depending on actual conditions of the retirement plan/fund • Age of retirement – 65

12. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Longevity Assumption • Life expectancy in HK projected for 2020. Male at 81, Female at 86 • Life expectancy in HK projected for 2030. Male at 82, Female at 87 • Mr. Wong has assumed to retire in 2025. • Mr. Wong’s health is good and considering his parents are already aged 75 & 78 in good health conditions. • Mr. Wong assumes a life expectancy of 81 years old. Mrs. Wong 86 • Expected duration of retirement – 17 years (Mr. Wong) 24years(Mrs. Wong)

13. Life Expectancy at Birth (Male and Female), 1971 - 2030 Year Female Male age age 1971 75 67 1990 80 74 2008 85 79 2020 86 81 2030 87 82 Source: Census and Statistics Department, HKSAR 2007

14. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Income Requirement Assumption • Will be based on the “expense method”, more accurate in Mr. Wong’s case as his current living style/standard are very expenditure oriented.

15. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Other Assumptions • Interest rate –based on HK average interest rate 2.97% from 1987 to2006 & 1.66 from 1988 to 2007 Mr. Wong choose 3% for long-term interest rate • Investment return– Pre retirement 11% (7% after inflation adjusted) • Investment return– Post retirement 8% (4% after inflation adjusted) • MPF return – 9% • These are reference from Hang Seng Index 13% (1988-2007) and Dow Jones 10% (1987-2006)

16. Hong Kong Dollar Saving Deposits Rate (% per annum) Average HKD Saving Deposit Rate (1987-2006) = 2.97% Source : Hong Kong Monetary Authority; Saving deposit rates on deposits of less than HK$100,000 (Period average figures)

17. Hong Kong Dollar Savings Deposit Rate(% per annum) Average HKD Savings Deposit Rate﹝1988-2007﹞= 1.66% Source: Hong Kong Monetary Authority; Savings deposit rates on deposits of less than HK$100,000 (Period average figures )

18. Hong Kong Hang Seng Index (1988-2007) 27,812.65 2,687.4 Average Return (1988-2007)= 13% Remark: Past performance is not necessarily a guide to the future Source: Yahoo Finance

19. Dow Jones Industrial Average Index 1987-2006 Average Return = 10% Source : Reuters (9/2007)

20. MPF Funds Past Performance

21. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Resources available • Resources available include 3 parts, • (a) Saving Part • Mr. Wong has HKD200,000 in saving account, with 3% return, the future value on the year of age 65 should be 200,000(1.03) exp17 = HKD330,570; • (b) Equity Part • With 11% return, the future value of his equity on the year of age 65 should be 300,000(1.11) exp17 = 1,768,528; • (c) MPF Part • There are now HKD265,000 in Mr. Wong’s MPF account, both he and his company invest HKD1,000 per month with 9% return, the total MPF value will be HKD2,034,192 after 17 years;(OP3) • So, on the year of age 65, the total resources will be • HKD330,570 + HKD1,768,528 + HKD2,034,192 = HKD4,133,290.

22. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET Retirement need Mr. Wong’s expected lifestyle

23. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Retirement Needs • As the information provided by Mr. Wong, he and wife need HKD334,000 at present value per year after retirement, that is, HKD167,000 per head, • Age 48 Age 65 Age 81 • Mr. Wong : • Pre-retirement post-retirement • 17 years 16 years • Age 45 Age 62 Age 86 • Mrs. Wong : • Pre-retirement post-retirement • 17 years 24 years • After inflation-adjusting, the expense needed each person after retirement should be, • 167,000(1.04) exp17 = HKD325,399 (OP1)

24. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • So, for Mr. Wong, the total amount needed for his 16 years’ retirement period at the present value on his age of 65 should be HKD3,790,480; (OP2) • For Mrs. Wong, the total amount needed for her 24 years’ retirement period at the present value on her age of 62 should be HKD4,959,822; (OP2) • The total amount needed should be, 3,790,480 + 4,959,822 = HKD8,750,302. • Retirement Gap: As the calculation above, the retirement gap needed should be, HKD8,750,302 - HKD4,133,290 = HKD4,617,012

25. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • How to fill in the gap - In order to fill in the retirement gap, we may discuss the solutions as below : • (a) Mr. Wong’s daughter will graduate 4 years later, that is, he will save HKD10,000 per month more at that time. If Mr. Wong chooses to invest into his retirement fund using the saved money, there will be HKD3,145,397 more on his age of 65 when retires; • (b) Mr. Wong’s son will graduate 7 years later, that is, he will save HKD10,000 per month more at that time. If Mr. Wong chooses to invest into his retirement fund using the saved money, there will be HKD2,006,641 more on his age of 65 when retires;

26. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • (c) Mr. Wong has surplus HKD50,000 per yearnow, there will be HKD2,225,042 more on his age of 65 when retires if he chooses toinvest into his retirement fund; • (d) Mr. Wong still has 10 years mortgage left, it means that he will save HKD240,000 per year more 10 yearslaterfor retirement purpose, that will be HKD2,347,985 more on his age of 65;

27. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • As a whole, Mr. Wong will saveHKD9,725,065which is larger than the retirement gapHKD4,617,012on his age of 65 as the analysis from item (a) to (d), (HKD3,145,397 + HKD2,006,641 + HKD2,225,042 + HKD2,347,985 = HKD9,725,065). • There are more than enough resources and funds for retirement, early retirement may be an option for Mr. Wong.

28. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • Retirement Planning Worksheet • ASSUMPTIONS • A1. Inflation rate prior to retirement 4% • A2. Inflation rate after retirement 4% • A3. Number of years until retirement 17 • A4. Expected duration of retirement 16 (24 for Mrs.Wong) • A5. Rate of return prior to retirement 11% • A6. Rate of return after retirement 8% • A7. Savings step-up rate to be determined if necessary • FINANCIAL CALCULATOR OPERATION PERFORMED • OP1. – Operation performed to find out the Inflation-adjusted annual retirement need • OP2. – Operation performed to find out the total resources needed for retirement • OP3. – Operation performed to find out the future value of the total current assets

29. 4. THE NEED ANALYSIS AND THE PLANNER’S WORKSHEET • COMPUTATIONS • L1. Projected annual retirement budget • L2. － Social Security benefit ___0____ • L3. = Net annual need in current dollars _167,000per head _ • L4. Inflation-adjusted annual retirement need _325,399 per head _ (per OP1.) • L5. = Total resources needed for retirement _8,750,302 total_ (per OP2.) • L6. Total in defined-contribution plans _265,000_ • L7. + Total private savings earmarked for retirement _500,000_ • L8. = Current assets available for retirement _765,000_ • L9. Future value of current assets _4,133,290_ (per OP3.) • L10. Annual income from defined-benefit plan ____0____ • L11. = Inflation-adjusted annual income from defined-benefit plan N/A • L12. = Lump-sum value of defined-benefit plan ___0____ • L13. Total resources available for retirement (line 9 and line 12) _4,133,290_ • L14. Additional amount you need to accumulate by retirement _4,617,012_

30. 5. PROPOSED SOLUTION AND OTHER CONSIDERATIONS • Proposed Solution: As seen from the previous analysis, Mr. Wong can easily meet his retirement needs. He can even choose to go into early retirement and enjoy his golden years while in relatively good health.

31. 5. PROPOSED SOLUTION AND OTHER CONSIDERATIONS • Other Considerations: • Financial aspect of Mr. Wong’s retirement could be further enhanced should he receive : - cash proceeds form sale of business - inheritance from parents - financial support from children - sales proceed from property

32. 5. PROPOSED SOLUTION AND OTHER CONSIDERATIONS • Forced early retirement might happen due to: - downturn or closure of business - health issues - caregiving health issues - macroeconomic changes

33. 5. PROPOSED SOLUTION AND OTHER CONSIDERATIONS • Planner should further remind Mr. Wong of: - longevity trend - escalating medical expenses - the importance of adequate insurance coverage - possible future tax rate or tax law changes

34. 6. CONCLUSION • Application of the theories and tools above has indeed help quantify the retirement pictures of our clients in HK. • The U.S. experience is that the application of these theories and tools have effectively alerted planners’ clients the need for retirement provision, and have made planners look more professional in front of clients. Should make the best use of tools like the time value of money tables at the end of Chapter 5. • This is true even to a greater extent in HK in which retirement planning is very much in its infant stage.

35. 6. CONCLUSION • While planners in HK should use these tools extensively, they should also try modifying them from time to time adding features relevant to HK. • Planners should note very unique cultural background and traditions in Hong Kong which warrant special Financial considerations:- • -- properties as very popular investments • -- young will never desert the Old • -- heavy funeral expenses • Changes in Hong Kong faster than any other place, much more frequent review of client’s plan desirable.

36. Q & A