Question

Consider two individuals, Smart and Notsosmart. Both graduated from college the same year and joined the same firm. They both receive a salary of $60,000. Mr. Smart started saving at age 25 for his retirement and started contributing 10 percent of his salary every year for the next 40 years. Mr. Notsosmart started thinking about retirement only after he was 40. What percentage of his salary must Mr. Notsosmart now save to reach the same nest egg as Mr. Smart? Assume 8% return on investments.

Answer 1

Mr Smart started saving at 25 years of age,

Per year saving = 10% of $60,000 = $6,000

Period = 40 years

Interest rate = 8%

Using TVM calculation,

FV = [PV = 0, T = 40, R = 8%, PMT = 6000]

FV = $1,554,339.11

This is value when Mr Smart is 65 years of age.

Mr Notsosmart started saving when he was 40 years of age to get equivalent amount upto 65 years of age,

Period = 25 years

FV = $1,554,339.11

Interest Rate = 8%

Using TVM calculation,

PMT = [PV = 0, T = 25, R = 8%, FV = 1554339.11]

PMT = $21,261.46

So, Mr Notsosmart needs to save $21,261.46 for 25 years to get equivalent retirement saving as of Mr Smart.