TOTAL, Money Tree’s in-depth financial planning software, captures details of clients’ situations with the ability to add future changes at any age. Future change tables are available throughout the planning data, allowing amounts to be changed, started or stopped anytime. The future change tables also allow the associated increase (or decrease) rate to be changed.
This blog post will break down and illustrate the relationship between the client’s age, dollar amount, and the increase rate for the future change tables.
The amounts entered in TOTAL are designed to be entered in today’s dollars. The amounts will increase (or decrease) based on the associated rate. When there are multiple future age entries, the amount will increase before the start age using the prior period increase rate.
Example – Earned Income:
Client Susan, age 58, is working her way up the ladder in her career. Her current salary is $105,000. Susan expects a promotion in the next two years which would increase her salary by $20,000 in today’s dollars. Her raises have typically amounted to 4% a year between promotions.
She plans on continuing her upward movement and would like her financial plan to factor an additional raise of $25,000 in today’s dollars five years from now. At that level, a portion of her income would be made up of revenue sharing and she believes her compensation would increase by at least 6% rate a year.
She wants to retire from her career at 60 but does not plan to completely exit the workforce. She expects to find something she loves earning about $75,000 a year at that time, with no expectation of the salary increasing.
- Age 48 – 3% Increase Rate – $105,000 (today’s dollars)
- Age 50 – 4% Increase Rate – $125,000 (today’s dollars)
- Age 55 – 6% Increase Rate – $150,000 (today’s dollars)
- Age 60 – 0% Increase Rate – $75,000 (future dollars)
TOTAL – Planning Data Entry:
TOTAL – Financial Planning Reports
*Green text = salary as entered in planning data
Age 48: $105,000 Present Value / $105,000 Future Value
For the client’s current age, earned income is exactly as entered, $105,000. The following amount is increased by 3%, amounting to $108,150.
Age 50: $20,000 Raise to $125,000 PV / $132,613 FV
By entering age 50 with a dollar amount of $125,000, the reports will increase the $125,000 by the prior period increase rate of 3%, amounting to $132,613. The amounts after age 50 will increase at the current period 4% increase rate. The following amounts are increased by 4%, amounting to $137,917 for age 51, and $143,434 for age 52.
Age 55: $25,000 Raise to $150,000 PV / $193,612 FV
By entering age 55 with a dollar amount of $150,000, the reports will increase the $150,000 by the prior period increase rates, which now includes a 3% increase for the first two years, and a 4% increase for the next five years. After age 55, the income amount will increase by 6%.
- Period 1 (48-50): $150,000 PV @ 3% for 2 years = $159,135 FV
- Period 2 (50-55): $159,135 PV@ 4% for 5 years = $193,612 FV
Age 60: Exit Career $42,589 PV / $75,000 FV
The age 60 career change provides more of a challenge, as Susan wants to plan to earn $75,000 at that time, not an inflated future value amount. Like the amounts above, the amount entered at age 60 will grow by the prior period increase rates.
Entering $75,000 for age 60 would amount to $129,579 on the reports:
- Period 1 (48-49): $75,000 PV @ 3% for 2 years = $79,586 FV
- Period 2 (50-54): $79,586 PV @ 4% for 5 years = $96,829 FV
- Period 3 (55-59): $96,829 PV @ 6% for 5 years = $129,579 FV
To include the future value of the income as $75,000 for the reports, the present value of $75,000 needs to be entered. The method is the same as above for supporting how the future value is calculated, except working to calculate the present value given the known future value, time periods and associated increase rates.
Calculating the present value of $75,000 for age 60:
- Period 1 (48-49): $46,064 FV @ 3% for 2 years = $43,420 PV
- Period 2 (50-54): $56,044 FV @ 4% for 5 years = $46,064 PV
- Period 3 (55-59): $75,000 FV @ 6% for 5 years = $56,044 PV
The amount entered for age 60 is $43,420, the present value of $75,000 as calculated above.