© 2013 Pearson Education, Inc. All rights reserved.16-1 Chapter 16 Retirement Planning

© 2013 Pearson Education, Inc. All rights reserved. 16-1

Chapter 16

Retirement Planning


Introduction

• Today, you’ve got to come up with retirements funds by yourself.

• Despite Social Security reform proposals, there might not be Social Security when you retire.

• Need to know about Social Security, employer-funded pensions, and current retirement plans.


Financing Social Security

• FICA taxes paid today are providing benefits for today’s retirees.

• The money you pay is not being saved up and invested in an account for you.

• Changes will be necessary, possibly increasing the retirement age or limiting benefits for the wealthy.


Retirement Benefits

• Benefits formula—replace 42% of average earnings based on number of earnings years, average level of earnings, adjustments for inflation, income brackets.

• Full benefits at the “full” retirement age.

• Reduced benefits at 62

• Increased benefits if you delay retirement.


Table 16.1 Estimated Monthly Social Security Benefit for Retiree Born in 1990(2012 Dollars)


Disability and Survivor Benefits

• Provided through mandatory Social Security insurance program.

• Protection for those with impairment that keeps them from work for at least 1 year.

• Monthly survivor benefits when breadwinner dies.

• One-time death benefit for funeral costs.


Defined-Benefit Plans

• Traditional pension plan where you receive “defined” pension payout at retirement

• Noncontributory retirement plan

• Contributory retirement plan


Defined-Benefit Plans

• Portability

• Vested

• Funded pension plan

• Unfunded pension plan


Cash-Balance Plans: The Latest Twist in Defined-Benefit Plans

• Workers are credited with a percentage of their pay each year, plus a predetermined rate of interest.

• Employers contribute a percentage of your salary each year into an account which grows at 30-year Treasury bond rate.

• Benefits easier to track and portable.


Plan Now, Retire Later

• Step 1: Set Goals– How costly a lifestyle will you lead?

– Do you want to live like a king?

– Do you have costly medical conditions?

– Will you relocate or travel?

– Do you want to live in your own home or retirement community.

– Decide on the time frame for achieving your goals.



• Step 2: Estimate How Much You Will Need

– Turn your goals into dollars by estimating how much you will need.

– Begin with 70-80% of current living expenses to calculate the cost to support yourself in retirement.

– Don’t forget about paying taxes.



• Step 3: Estimate Income at Retirement

– Once you know how much you need, figure out how much you’ll have.

– Estimate Social Security benefits and determine what your pension will pay.



• Step 4: Calculate the (Annual) Inflation-Adjusted Shortfall

– Compare the retirement income needed with the retirement income you’ll have.



• Step 5: Calculate How Much YouNeed to Cover This Shortfall

– Know your annual shortfall in your retirement funding.

– Know how much must be saved by retirement to fund this shortfall.



• Step 6: Determine How Much You Must Save Annually Between Now and Retirement

– Put money away little by little, year by year.

– Use online retirement planning websites


Defined-Contribution Plan

• You and employer or your employer alone contributes directly to a retirement account set aside for you.

• A savings account for retirement.


Defined-Contribution Plans

• Profit-Sharing Plans

• Money Purchase Plan

• Thrift and Savings Plan

• Employee Stock Ownership Plan (ESOP)

• 401 (k) Plan


Retirement Plans for the Self-Employed and Small Business Employees

• Keogh Plan or Self-Employed Retirement Plan

• Simplified Employee Pension Plan (SEP-IRA)

• Savings Incentive Match Plan for Employees or SIMPLE plan


Individual Retirement Arrangements (IRAs)

• Traditional IRA

• Roth IRA

• Coverdell Education Savings Account (known as Education IRA)


Traditional IRAs

• Tax advantaged—contribution may or may not be tax-deductible depending on individual’s level of income and whether he/she, or spouse, is covered by a company retirement plan.

• Restrictions on timing and amount of withdrawals but can rollover a distribution.

• Saver’s tax credit


The Roth IRA

• Contributions are not tax deductible but made out of after-tax income.

• Money grows tax free and withdrawals are tax free.

• No withdrawal restrictions or tax penalty like traditional IRA but can also rollover.


Traditional Versus Roth IRA: Which is Best for You?

• You end up with the same amount to spend at retirement, if both are taxed at the same rate.

• Choose the Roth IRA if you can pay your taxes ahead of time.


Saving for College: 529 Plans

• Tax-advantaged savings plan used for college and graduate school.

• Contribute up to $250,000, grows tax-free.

• Plans are sponsored by individual states, open to all applicants regardless of where they reside.

• Invest directly or through financial advisor.


Facing Retirement—The Payout

• Plan ahead before you decide how you receive a payout.

• Look at all your retirement plan payouts together—may want some in lump sum, others as annuity.

• Use diversification and time dimension of risk when deciding what to do with funds.

Documents

© 2013 Pearson Education, Inc. All rights reserved.16-1 Chapter 16 Retirement Planning